Senior Federal Reserve officials say they are determined to squash “stubbornly high,” inflation even if it requires higher interest rates and steeper unemployment to bring price pressures back under control.
John Williams, president of the New York Fed, said Friday in an interview with Bloomberg that inflation has started to ease. But it needs to slow a lot further before the Fed eases up on the monetary brakes.
San Francisco Fed President Mary Daly echoed Williams’ view in an interview with the American Enterprise Institute. She said inflation is likely to take longer than she previously believed to slow to the low levels that prevailed before the pandemic.
“I don’t know why markets are so optimistic about inflation,” said Daly, referring to recent optimism among investors that the Fed was finally gaining the upper hand.
Cleveland Fed President Loretta Mester, in a separate interview with Bloomberg, said the bank needs to see more evidence that inflation is going to decline.
“The level of inflation is still way too high,” she said.
The remarks by Williams, Daly and Mester reinforce the message Fed Chairman Jerome Powell delivered on Wednesday after the latest rate hike.
The central bank on Wednesday raised a key short-term interest rate by half a percentage point to a top end of 4.5%, marking the seventh increase since March. Higher interest rates reduce inflation by slowing the economy.
The Fed also signaled it plans to raise the so-called fed-funds rate to as high as 5.25% in 2023. Williams said his colleagues expect it to get to 5% to 5.5% next year.
“Real interest rates need to get restrictive and stay there,” he said.
In market parlance, a real interest rate is one that is above inflation. The rate of inflation right now, using the Fed’s preferred PCE price gauge, is 6%. That’s markedly higher than the current 4.25% to 4.5% fed-funds rate.
Williams said he doesn’t expect the short-term rate to reach 6%, although he didn’t rule it out.
Once interest rates hit a peak, all three Fed officials suggested rates should stay high for an extended period before the central bank reverses course. Daly indicated it could be about a year.
The Fed is aiming to bring the rate of inflation down to its 2% target over the next few years. The PCE price gauge rose at a 6% annual rate as of October, down from a 40-year peak of 7% in June.
The Fed on Wednesday updated its forecast for the economy to show sharply slower growth and rising unemployment.
“We’re going to feel like we are in a sluggish economy,” Daly said.
Still, Fed officials said the economy is not in recession right now and that it’s proven to be quite resilient.
The Fed’s biggest concern is high inflation in services, which represent the largest part of the economy and is closely tied to the cost of labor. Service inflation can be quite sticky and harder to eradicate than inflation in goods.
“The underlying issue of of core services inflation is still very much there,” Williams said.
Mester agreed. “I haven’t seen a lot of evidence service inflation is coming down.”
Daly said demand for labor not only needs to slow, but that unemployment has to rise to temper a surge in wages that is now making inflation harder to suppress.
“A lot of inflation is tied to the labor market,” she said.
In the 12 months ended in November, service inflation rose 6.8%, the fastest pace since 1982.
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