NICK TIMIRAOS: The Labor Department reported this morning that inflation rose 7% last year, a 40-year high. And at the last Fed meeting, you and most of your colleagues projected that inflation could fall to about 3% this year or maybe a little lower using a slightly different measure of inflation, the personal-consumption spending price index. So, Loretta, what’s your forecast for inflation this year? And what are the risks around your forecast?
Loretta Meester: That’s a good question, Nick. There are a lot of things that are pushing up the inflation readings now. At the beginning of last year this was mainly because of the pandemic situation – the reopening of the economy, people wanted to buy what they could not afford as easily as before. There were also supply chain issues that were holding back the supply of those goods. And then, now wages are rising. So we’ve gone from that to something broad basically driven by the pandemic situation, and that’s where I think the focus is on the Fed.
If you look at today’s report – the main measure you take out food and energy, which gives you a good underlying measure of where inflation is going – that’s also very high, and inflation is above 2%. So I think as some of the supply constraints ease, and if we can get past the pandemic and normalize the situation in labor markets a little more, we’ll see inflation measures back down. But it is up to the Fed to move away from the extraordinary accommodations we needed to put in place during the pandemic. So it’s not like you can think about what happens to inflation independent of what happens with monetary policy.
Mr. TIMIRAOS: So let’s move on to monetary policy. At your last meeting, many of your colleagues thought it would be appropriate for the Fed to raise interest rates about three times this year, and I know you said that was your estimate as well. But if you do that and even if inflation slows this year, real rates could still be quite negative. So the question is, will the Fed have to do more than just raise interest rates a few times to keep the economy from overheating?
M / s. Meester: Well, we write those projections that are based on our outlook for the economy, and we’ll have to see, right? I mean, in December I wrote three. We’re going to make new guesses. We’ll have a meeting in a couple of weeks and then on new estimates later. [March] meeting. So you always have to look ahead and anticipate what’s going to happen.
If you look on the way [Summary of Economic Projections], it is not only three rate hikes this year and is stalling; It was an upward inclination towards that path. Then we’ll see. Depending on what happens in the economy, those few more rate hikes will have to go ahead. Or it could be that what we are doing with the balance sheet combined with the rate hike, we can get inflation under control. The key thing is that we’re focused on our goals, and those goals are to take inflation down to our long-term target of 2%. It’s well above that now, and I think we need to take action to make sure we can take that down and that long-term inflation expectations remain well placed. And so now this is the task.
I think the case is very compelling that we remove the housing. And our policy tool is one of those tools, but we’ll also look at what we can do with our balance sheet to bring down the level of assets on our balance sheet, as well as, the upward trajectory Compatible with. Fund rate.
Mr. TIMIRAOS: And the Fed, of course, is still buying bonds as part of the stimulus program that started in 2020. It is due to end in March. Would you support raising interest rates at that March meeting if the economy looks broadly what it is now?
M / s. Meester: Yeah, I think it’s a compelling case. If things happen today in March, I’d support zero-to-raise raises at that point. I mean, if you look at the labor markets, they’ve improved faster and they’ve improved faster than many economists expect them to. According to several metrics, they are at or even above pre-pandemic conditions. It is true that labor-force participation, its level has not gone back to where it was pre-pandemic, but you also have to remember that there is a downward trend in labor-force participation due to demographics. So we’re basically back on that trend.
And even though I think labor-force participation is going to grow back once we get through the pandemic, we have to make policy in a policy-relevant time frame. So if I’m looking at the maximum employment position in the labor market right now, we’ve met that criterion, and inflation is above 2%. So there is a really compelling case in my mind that we move away from the extraordinary housing that was needed during the early parts of the pandemic. But we’re not in that economy anymore, and I think it’s time.
Mr. TIMIRAOS: Loretta, you’ve been attending Federal Open Market Committee meetings since 2014 as chairman of the Cleveland Fed, which is the rate-setting committee, which means you were there for the last cycle of raising interest. Rate, which happened after a few fits and starts. But you raised interest rates or tightened policy almost every other meeting. And our audience may not know this, but you were director of research at the Philadelphia Fed before that, which means you’ve been attending FOMC meetings since 2000. And in a tight cycle during the first decade of this century, the Fed raised rates at every meeting. So the question I have is: do you envision a cycle like the last one right now, with the Fed gradually raising rates every other meeting, or can we see something more like the experience before that where you Were raising interest rates continuously in policy meetings?
M / s. Meester: Well, it would really depend on how the economy plays out, right? So it’s hard to predict what we’re going to do. The SEP gives you a good idea by December of what we think – everyone thinks about the appropriate policy, and then we show that middle path.
You know, I have my own view, where the economy is right now, well, I would support March 1 growth if that’s the way the economy looks. I am always cautious about what we are going to do in March. I mean, the economy can surprise. It’s been amazing. But you know, pandemic is something new. We have to look at the economy, and then we have to see where it goes.
So three rate increases – I know the market has four increases. We’ll see that as we get through the year where we need to be on policy. Importantly, we must take policy action to ensure that long-term inflation expectations remain in line with our 2% target.
So now you can look at those longer-run measures of expectations and take some comfort in that they — maybe they’re a little above 2%, but they’re basically in line with 2% inflation. But you have to remember that built into those expectations the Fed is taking appropriate action. So it is up to us to really focus on achieving our dual mandate goals.
And I think what I’ll focus on here is that we had to do housing very early in the pandemic, but now the economy is basically back to full employment from a policy-relevant time frame point of view and we’re going to have inflation. are above. So we are going to increase the rates to meet our targets. And then we’ll see how that impacts the economy going forward.
We have to write a policy path in those SEPs, but we look at the data continuously. You know, when they say the Fed is dependent on data, it means that we’re always recalculating our policy ideas based on what incoming data is telling us about the current economy, but Also that incoming data is telling us where the economy is likely to go. Because, of course, as you know, Nick, we take policy action and it takes some time for it to affect the full breadth of the economy.
Mr. TIMIRAOS: You mentioned the Fed’s balance sheet. That’s a nearly $9 trillion portfolio of bonds and other assets, which doubled during the pandemic as the Fed acted first to prevent a complete recession in financial markets and later to provide stimulus. How much restraint do you expect to shrink the Fed’s balance sheet by $3 trillion over the next few years? Is it equivalent to a percentage point of the Fed rate hike, 2 percentage points to the Fed rate increase? How tight do you think this program can be?
M / s. Meester: Well, there are rules of thumb about it, and the rules of thumb are based on both of the previous [quantitative easing] We had programs, when we expanded the balance sheet, and when we contracted it. But the lesson from those studies is that it’s really dependent — the effects depend on where the economy is at the moment. If you think about the impact of the first quantitative easing program during the last financial crisis and recession, it had a big impact because the markets were really disrupted at that time. And in doing so quantitative easing was more effective, at least that’s what the study tells us.
So, again, I think we need to be a little cautious and a little bit polite about putting numbers…