Federal Reserve President Tells Americans to Brace for ‘Extended’ Period of High Interest Rates

President of the Federal Reserve Bank of Minneapolis Neel Kashkari speaks during an interview in New York, on March 29, 2019. (Shannon Stapleton/Reuters)

Minneapolis Federal Reserve Bank President Neel Kashkari said in a podcast interview that Americans are so fed up with inflation that they’re inclined to tolerate a recession if it means price pressures will fall, while warning consumers to brace for the prospect of high interest rates for an “extended” period.

Mr. Kashkari made the remarks in an episode of the Financial Times’ “Economics Show,” noting that the U.S. central bank is to some extent confounded as to why inflation has been “much longer lasting” than the Fed’s models predicted.

“It should have been impossible using our traditional models for high inflation to hit us. Yet we saw very high inflation,” Mr. Kashkari said.

He called on his colleagues at the Fed to engage in “a lot of serious reflection on what [the] models are missing in terms of possible sources of inflation.”

Although the Fed’s inflation models allow for economic shocks to be taken into account in forecasting, such as the pandemic-era supply-shock disruptions and massive fiscal and monetary stimulus, economists at the central bank who rely on the models to make predictions about price pressures still “got a lot wrong,” he said.

“Even if we’d been able to write down all the shocks exactly in advance, our models would have come nowhere close to forecasting the actual inflation that has hit us,” he said, adding that his policymaking colleagues at the Fed should keep an open mind about the many possible ways by which inflation could reappear.

Mr. Kashkari then said that the 5.25 to 5.5 percent range that the Fed’s benchmark interest rate is currently sitting at doesn’t appear to be having as much downward pressure on demand as he assumed. He suggested that some of the dynamics of the reopening economy are a factor.

‘Inflation Is Worse Than a Recession’

Commenting on the appropriate stance of monetary policy, meaning what the target federal funds rate should be, Mr. Kashkari called for higher-for-longer interest rates.

“I think right now, my best guess is we would leave it here for an extended period of time until we get a lot more data to convince us one way or the other,” he said. “Is underlying inflation really on its way down?”

The Fed’s preferred inflation gauge (and a measure of underlying inflation), the core personal consumption expenditures price index, rose by 0.2 percent in April month over month, and by 2.8 percent year over year. That’s substantially higher than the Fed’s 2 percent target.

“I’m not sure how tight policy is,” Mr. Kashkari admitted. “Maybe we’re on track for a soft landing to 2 percent, or maybe we’re landing softly at 3 percent.”

He said that because the labor market is strong, the Fed has the luxury of being able to wait for longer with interest rates at higher levels before cutting.

Mr. Kashkari said that U.S. consumers have become so fed up with high inflation that they seem inclined to support higher interest rates to bring it down, even if it means tipping the economy into a recession.

“I have learned that the American people—and maybe people in Europe equally—really hate high inflation. I mean, really viscerally hate high inflation,” he said.

The Minneapolis Fed chief recalled a conversation with a labor leader who represented low-income service workers during one of the many roundtables that Mr. Kashkari said he held with small businesses, labor groups, and workers.

“She said to me, ‘Inflation is worse than a recession,’” Mr. Kashkari said, noting he was surprised as this view is contrary to conventional economic thinking because, during a recession, there’s a higher likelihood of losing one’s job, whereas inflation just takes a bigger bite out of one’s paycheck.

Mr. Kashkari said the labor leader told him that members are used to dealing with recessions and that they tend to rely on friends and family to get through one, but that high inflation affects everyone.

“There’s no one I can lean on for help because everyone in my network is experiencing the same thing,” the labor leader said, according to Mr. Kashkari.

“That was a profound comment for me to hear,” Mr. Kashkari said.

The Minneapolis Fed chief’s remarks dovetail with statements he made at a Barclay’s event in London and during an interview on CNBC on May 28, when he urged his colleagues at the central bank to wait for “many more months” of data showing inflation is trending down before lowering interest rates.

Mr. Kashkari also did not rule out further rate hikes if inflation picks back up again.

Markets are pricing in a single 0.25 percentage-point rate cut this year (which would bring the rate down to 5–5.25 percent) at the Fed’s policy meeting of the Federal Open Market Committee (FOMC) on Sept. 18, according to the CME FedWatch Tool, which is a measure of investor expectations based on futures contracts. A second 25 basis-point rate cut is expected around the end of the year.

However, Mr. Kashkari’s remarks make it clear that those odds could shift to a higher-for-longer scenario if inflation remains elevated, which would keep borrowing costs elevated and have a cooling effect on the economy.

The latest Conference Board data on consumer confidence indicate that consumers’ perceived likelihood of a recession over the next 12 months rose in May. Also, consumers’ assessment of their financial situation both currently and over the next six months has seen a slight decline.

One of the effects of high interest rates is that home ownership is becoming out of reach for many Americans, especially first-time homebuyers. For instance, prospective homebuyers need to earn nearly twice as much as they did four years ago to afford a typical home today, according to a recent study by Redfin.

Prices have risen by 19.9 percent since January 2021, according to the latest inflation data from the government’s consumer price index report.

In some categories, the pace of inflation is even higher. For example, rent is up by 20.8 percent, grocery prices are up by 21.3 percent, and car repairs are up by 30.2 percent, according to the report.