Fed research shows that it’s more costly for policy makers to be wrong about inflation expectations being well anchored when they are not, as opposed to erroneously assuming they are rising when they’re actually well anchored, Mester said Wednesday in remarks prepared for delivery to the European Central Bank’s annual policy forum in Sintra, Portugal.
“These simulation results, coupled with research suggesting that persistent elevated inflation poses an increasing risk that inflation expectations could become unanchored, strongly argue against policy makers being complacent about a rise in longer-term expectations,” Mester said.
In an interview earlier with CNBC, Mester said the Fed is “just at the beginning of raising rates” and that she wants to see the benchmark lending rate reach 3% to 3.5% this year and “a little bit above 4% next year” to rein in price pressures even if that tips the economy into a recession.
She also said if the economic conditions remain the same as now she would back another 75 basis points hike when officials next gather in July.
The Fed earlier this month raised interest rates by 75 basis points, the largest increase since 1994, as it battles the highest prices in 40 years. Policy makers had been telegraphing a 50-basis-point move before the meeting, but quickly changed course when, days before the June 14-15 gathering, a preliminary survey showed rising inflation expectations.
A final reading of the University of Michigan’s longer-term US consumer inflation expectations, published Friday, settled at 3.1% for June, down from the initial report of 3.3%, which would have been a 14-year high. Fed officials keep a close eye on barometers of consumer price sentiment, and have expressed concern about expectations becoming unanchored and leading to runaway inflation.
Mester said long-term inflation expectations are rising and may continue to do so as gasoline and food prices remain elevated.
“The current inflation situation is a very challenging one,” Mester said Wednesday. “Central banks will need to be resolute and intentional in taking actions to bring inflation down.”
Mester said the current inflation climate, which is partly being driven by supply-side shocks, belies the view that central banks should err on the side of being too accommodative, popular in the pre-pandemic era where low inflation was the main challenge for policy makers.
“It also calls into question the conventional view that monetary policy should always look through supply shocks,” Mester said. “In some circumstances, such shocks could threaten the stability of inflation expectations and would require policy action.”
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Source: Economy - investing.com
