Richmond Fed Prez Jeffrey Lacker became the second Fed district bank president to predict that the Fed would need to raise rates next year, ahead of the FOMC target of 2014. Charles Plosser of the Philly Fed made a similar prediction yesterday. The fact remains however that the Fed is way behind the curve in recognizing inflation.
Here are a few quotes from Lacker’s speech today.
Some critics see this moderate pace of expansion as prima facie evidence that the Federal Reserve should provide more economic stimulus in order to boost growth. I disagree, as I will attempt to explain. While frustration with current economic conditions is understandable, our economy’s performance is nonetheless comprehensible, given what has befallen us over the last few years. Moreover, the reasons for more moderate growth suggest that further monetary stimulus is not likely to be of much help.
No central banker’s outlook would be complete without a forecast for inflation. Last year, we were reminded that inflation can rise even in the face of elevated unemployment. In 2010, the inflation rate was 1.3 percent, but it then more than doubled to 2.7 percent last year, even though the unemployment rate averaged about 9 percent. Despite that run-up, I believe that the inflation outlook is reasonably good right now. The most recent reading on inflation is 2.1 percent, on a year-over-year basis. While gasoline prices pushed up the overall inflation rate last year and early this year, gasoline prices have fallen in recent weeks, and futures markets are pricing in further declines this year.
More important, in my view, is that the public’s expectations of future inflation have remained well anchored within the range they have been in for several years. Much of that stability can be attributed, I believe, to the Federal Reserve’s consistent pursuit of monetary policy that keeps inflation low and stable.
What’s he smoking? This is emblematic of the problem that I keep referring to that the Fed follows lagging inflation measures of only those items which typically inflate slowly, if at all, putting it way behind the curve. Headline CPI at 2.7% is already above the Fed’s target. CPI of all items excluding shelter, which has been a depressant on the index, is at 2.9%. The BLS also reports that average weekly earnings of all employees has risen by 2.7% in the past year.
The Fed looks only at the core PCE, which is only available quarterly with a lag and it excludes food and energy, which, while volatile have been rising at much faster rates over the longer haul.
Speaking of monetary policy, some of you may have noticed that in all three FOMC meetings this year I have cast a dissenting vote on the Committee’s monetary policy decision. In each case, I objected to a phrase contained in the press release following the meeting. As background, before last August, the FOMC’s press release following our meeting stated that “the Committee … currently anticipates that economic conditions … are likely to warrant exceptionally low levels for the federal funds rate for an extended period.” This has come to be known as our “forward guidance language.” At our meeting last August, we changed “for an extended period” to “at least through mid-2013,” a more specific calendar-based way of providing forward guidance. Then in January, the FOMC voted to change that date to “late 2014.”
It’s important to recognize that our forward guidance language is a forecast of how monetary policy will turn out, not an unconditional promise. Future monetary policy decisions will depend on future economic data — and the future economic outlook. As new data arrive, the outlook for future economic conditions will change, and the outlook for the future of monetary policy should change as well.
I dissented in January because I did not believe that economic conditions are likely to warrant low interest rates all the way through 2014. (I was not a voting member last year.) My projection is that if we want to keep inflation at 2 percent, we will likely need to raise rates in 2013.
Since inflation is already above target, it is only the fact that the Fed is behind the curve that is keeping it to the forecast of holding rates at zero until 2014. As the PCE begins to catch up with reality, probably in the third quarter, more FOMC voting members will be forced to see the light. The markets will begin to sniff out the coming tightening simulataneously.