The Federal Reserve could achieve a rarity of vanquishing inflation without destroying the U.S. labor market or triggering a recession, says Chicago Fed Bank President Austan Goolsbee. But the regional central bank chief warned that the “traditionalist view” of monetary policy—fighting inflation through economic pain—could result in “a near-term policy error.”
Speaking at the Peterson Institute for International Economics (PIIE) on Sept. 28, Mr. Goolsbee purported depending too much on past economic data in previous inflation battles to plot future policy decisions is a mistake. He did not endorse further rate hikes, but Mr. Goolsbee, who previously served in the Obama administration, expressed caution in his talk titled “The 2023 Economy: Not Your Grandpa’s Monetary Policy Moment.”
The conventional utilization of monetary policy “misses key features of our recent inflationary experience” and focuses on the “inevitability of a large trade-off between inflation and unemployment.” This strategy, Mr. Goolsbee noted, “is a recipe for overshooting and causing an unnecessary downturn.”
Instead, central bank policymakers would be better served to concentrate on various decelerating core inflation components, such as cooling housing costs, and stability in the broader economy, like subsiding supply shocks.
“The unwinding of supply shocks, the composition of demand returning to more stable patterns, and Fed credibility are central to why I think it might be possible today to reduce inflation while avoiding a deep recession,” he said.
With the public’s inflation expectations “well-anchored,” the Fed can allow price pressures to diminish “with less economic pain that was needed in the past.”
Looking ahead, Mr. Goolsbee agreed that a soft landing was possible, but there are still risks threatening the economy, like the United Auto Workers (UAW) strike, increasing crude oil prices, the Chinese economic slowdown, and a potential U.S. government shutdown.
‘Meaningfully Higher’
Minneapolis Fed Bank President Neel Kashkari believes there is a chance that interest rates might need to be “meaningfully higher” to bring inflation back down to the central bank’s 2 percent target.“Once supply factors have fully recovered, is policy tight enough to complete the job of bringing services inflation back to target?” Mr. Kashkari wrote. “It might not be, in which case we would have to push the federal funds rate higher, potentially meaningfully higher.”
“Today, I put a 40 percent probability on this scenario,” he added.
Like Mr. Goolsbee, the Minneapolis Fed chief warned that the economy still faces a series of shocks, such as the war in Ukraine, the disruption to the auto sector, and “spillovers from the slowing Chinese economy.”
Mr. Kashkari told CNBC on Sept. 28 that a restrictive rate—a neutral policy rate that neither stimulates the economy nor slows it down—may need to be higher.
“It’s possible, given the dynamics of the reopening of the economy, that the neutral rate may have moved up,” he said, adding that he is concerned by the resilient consumer and stronger-than-expected GDP.
The Future of Interest Rates
This month, the Fed kept its benchmark fed funds rate at a target range of 5.25 percent and 5.5 percent, the highest level in more than two decades.Rather than pulling the trigger on more rate hikes, the Fed can fire off “more subtle moves going forward,” like continuing to trim its more than $8 trillion balance sheet, says John Lynch, the CIO at Comerica Wealth Management.
“Increased Treasury security issuance should lead to higher market interest rates, as global investors demand higher yields,” Mr. Lynch wrote in a research note. “We believe these trends should allow Fed Chair Powell to avoid having to raise rates in the upcoming election year, potentially freeing the central bank from political interference.”
He added that the tight policy is likely to “persist,” and the Fed’s latest moves support the case for a higher-for-longer interest rate policy.
The next two-day FOMC meeting will take place on Oct. 31 and Nov. 1.