MNI: Fed’s Mester Says Bigger Risk Is Tightening Too Little

There is still a high risk of U.S. inflation rising further or remaining stubbornly high and the Federal Reserve should err on the side of tightening too much, Cleveland President Loretta Mester said Thursday.

“Despite the moves we have made so far, given that inflation has consistently proven to be more persistent than expected and there are significant costs of continued high inflation, I currently view the larger risks as coming from tightening too little,” Mester said in prepared remarks to the Princeton Bendheim Center for Finance.

The Fed has raised interest rates 375 basis points this year to a 3.75% to 4% range. It is expected to slow the pace of hikes to 50 basis points in December after a weaker-than-expected 7.7% rise in CPI in the year to October.

“As policy moves further into restrictive territory, the effects of our cumulative tightening will work through to the broader economy, and I anticipate that we will see inflation pressures ease,” Mester said. “At that point, I expect that my view of the balance of these risks will shift, and I will welcome that shift because it will mean that inflation is moving down in a meaningful way.”

UPSIDE RISKS

Mester said she is heartened by well-anchored long-run inflation expectations but added the Fed cannot be complacent about that stability.

“The longer actual inflation and near-term inflation expectations remain elevated, the greater the risk that longer-term inflation expectations become unanchored and high inflation permeates wage- and price-setting behavior and investment decisions, making it much more costly to return inflation to our goal,” she said.

Mester cited upside risks to inflation.

“Russia’s continuing war against Ukraine could mean gas and energy prices move higher again this winter and next winter. And I remain cognizant of the fact that economists’ forecasts – private sector, the FOMC’s, and my own – have underestimated the level of inflation and its persistence for almost two years,” she said.

Richmond Fed President Thomas Barkin told MNI this week interest rates will likely need to move higher than previously thought even as the Fed slows the pace of rate hikes. (See: https://marketnews.com/mni-interview-fed-s-barkin-prices-may-force-higher-rates-peak)