The Wall Street Journal
Central bank’s No. 2 official noted that previous and anticipated rate increases will slow the economy in ways that can’t be observed yet
By Nick Timiraos
Two Federal Reserve officials began laying out a case for exercising caution in raising interest rates after policy makers last month telegraphed plans to continue lifting rates at their fastest pace in decades to reduce inflation that has reached 40-year highs.
Fed Vice Chairwoman Lael Brainard noted how previous rate increases, together with anticipated further rate increases, will slow the economy in ways that can’t be observed yet during a speech Monday at a conference of business economists in Chicago.
Ms. Brainard said the Fed was likely to continue raising rates and maintaining them at higher levels to ensure inflation comes back to the Fed’s 2% target. But her speech was laced with reasons to expect inflation to soon diminish, which could in turn stay the need for the Fed to raise rates beyond levels already anticipated by investors.
“It will take time for the cumulative effect of tighter monetary policy to work through the economy and to bring inflation down,” she said. “The moderation in demand due to monetary-policy tightening is only partly realized so far.”
The Fed has raised rates by 3 percentage points since March, the most rapid interval of rate increases since the early 1980s. Its most recent increase last month brought the benchmark federal-funds rate to a range between 3% and 3.25%. Officials last month penciled in additional rate rises that could lift the rate above 4.5% by early next year.
Earlier Monday, Chicago Fed President Charles Evans said under his current outlook for the economy, it would be appropriate for the central bank to pause rate increases at slightly more than 4.5% by next March and then to assess how the economy was reacting. Ms. Brainard, who is part of the inner circle of policy-shaping discussions with Fed Chairman Jerome Powell, didn’t elaborate on her rate outlook.
Fed officials dialed up plans to raise interest rates throughout the summer because inflation readings defied hopes that price pressures would decelerate. Investors expect the Fed to raise rates by 0.75 percentage point at their next meeting, Nov. 1-2.
“Our rapid pace of rate increases has fast-tracked our arrival to such a restrictive stance,” Mr. Evans said. He warned of the costs of “overshooting” on rate rises. “This puts a premium on the strategy of getting to a place where policy can plan to rest and evaluate data and developments,” he said.
Speaking to reporters later Monday, Mr. Evans said he was worried about overreacting to additional reports of stronger-than-anticipated inflation. “We could get a few of those, and if we’ve already done” so many rate increases, “that sort of puts us at somewhat greater risk of responding overly aggressive,” he said.
Mr. Evans said even though, in theory, the Fed could cut rates if it concluded it had raised them too high, he didn’t think such a strategy would be as easy to execute in practice.
Mr. Evans said the Fed has effectively decided to raise rates over the next few months to levels that are designed to restrict growth without much sensitivity to the underlying data. As a result, he said the strategy “puts a premium on expressing the idea that” a Fed policy rate of slightly more than 4.5% “is a place to rest.”
Fed officials have said they expect declining commodity prices and easing supply-chain bottlenecks to bring inflation down in the coming months, but officials have noted concern that inflation might still remain well above their 2% target because of strong wage growth and more persistent price pressures in the labor-intensive service sectors of the economy.
Ms. Brainard pointed to developments that could bring economic growth to slow more rapidly as tighter monetary policy ripples through the economy. Those include recent revisions to household income data that show consumers might have less of a savings buffer than previously thought as well as rapid rate increases by central banks across the world.
Many countries are dealing with high inflation, and as the Fed raises rates, the dollar is strengthening against foreign currencies, which could require foreign central banks to raise rates to prevent capital outflows or higher inflation.
“The combined effect of concurrent global tightening is larger than the sum of its parts,” said Ms. Brainard. “In light of elevated global economic and financial uncertainty, moving forward deliberately and in a data-dependent manner will enable us to learn how economic activity, employment and inflation are adjusting to cumulative tightening in order to inform our assessments of the path of the policy rate.”
Ms. Brainard also nodded to the risks of financial instability as businesses and financial institutions adjust to higher interest rates after being conditioned by central banks to expect lower interest rates to persist. Last month, the Bank of England intervened to stabilize U.K. bond yields after government spending and tax-cut proposals sparked upheaval.
“Liquidity is a little fragile in core markets,” Ms. Brainard said during a question-and-answer session, referring to the ability to quickly buy or sell large volumes of certain U.S. Treasury securities or government-guaranteed mortgage-backed securities.
Still, Ms. Brainard disputed the premise that the central bank would be constrained to fight inflation by raising rates because of higher debt levels. The government’s economic-policy response to the pandemic had improved the balance sheets of households and businesses, for example, by allowing firms to refinance maturing debts at lower yields.
“Businesses have better debt servicing on average,” she said. “That gives us a bit of a better starting point than you might have seen otherwise.”
Nick Timiraos is chief economics correspondent for The Wall Street Journal and is based in Washington. He is responsible for covering the Federal Reserve and other major developments in U.S. economic policy. Previously, Nick covered the Treasury Department and U.S. housing and mortgage markets, including the government’s response to the foreclosure crisis and its control of finance companies Fannie Mae and Freddie Mac. He contributed to the Journal’s presidential election coverage in 2008 and joined the Journal in 2006. Nick is the author of “Trillion Dollar Triage” (Little Brown, 2022), which chronicles the U.S. economic-policy response to the Covid pandemic.