WASHINGTON (Reuters) – The U.S. Federal Reserve ought to be in a position to lift interest rates much longer or over quickly than currently expected to insure against an increase in inflation from a U.S. economy operating near full employment.
That may be the message that is percolating up from senior central bank staff economists to policymakers including Fed Chair Jerome Powell in research that’s helped inform a subtle change in how Powell intentions to steer policy amid growing uncertainty about concepts for example full employment plus the neutral level of rates of interest.
The latest example emerged soon from staff economist Robert Tetlow, who argued that uncertainty for the stability of inflation expectations really should be met using a strong reaction to ensure that one round of price increases isn’t going to touch off further rounds as inflationary psychology shows its head.
Tetlow’s paper, released , follows Powell’s own remarks on Friday morning through which he explicitly cited potential risk of unanchored inflation expectations as among the cases "whereby doing inadequate is sold with higher costs than doing a lot."
Referring to a general rule of thumb among central bankers – that smaller, more cautious policy responses are suitable in the face of uncertainty about key economic parameters – Tetlow said the central bank shouldn’t be shy if policymakers are unsure about inflation's "persistence."
"The best reaction to uncertainty concerning inflation persistence isn’t customary policy attenuation…instead anti-attenuation, meaning a very aggressive response," wrote Tetlow, a senior adviser inside the Fed's Monetary Affairs division.
Powell on Friday signaled he was cautious about how accurately the Fed can estimate a lot of the variables which have been essential to the U.S. central bank's styles of the economy, along with the degree of full employment as well as the "neutral" monthly interest, and was thus unwilling to be guided strictly simply because they interact.
"A skeptic would declare that the models aren't working – and this is what Powell is indirectly saying," Robert Eisenbeis, chief monetary economist with Cumberland Advisors, wrote today. "His fact is to select from risk management," or weighing the fee for a blunder option of direction and selecting the less costly option.
In the existing situation, which would mean continued and maybe even faster rate hikes to guard against inflation, in lieu of holding rates lower to find out whether unemployment can drop further without accelerating the interest rate of price increases. Some regional Fed officials have created except case, arguing there is not any reason to lift rates until inflation takes off.
But "the beginning to the economy…increases the costs of underestimating" full employment, as happened while in the 1960s when efforts to get down the unemployment rate touched off high inflation, Goldman Sachs (NYSE:GS) analyst Daan Struyven wrote inside an analysis of Powell's remarks plus the new staff research.
Though prices today are better anchored when compared to the 1970s, "the concern about labor market overshooting is likely to drive steady tightening until payroll growth slows," Struyven wrote, reiterating Goldman's view that this Fed will raise rates 4x the coming year and also more times this year.
That is slightly faster compared to Fed itself anticipates.