Dudley, in a Bloomberg Opinion piece, argues that a larger cut is necessary to prevent a potential recession and align monetary policy with the Fed’s dual mandate of price stability and maximum sustainable employment.
He highlights that while both price stability and employment are currently more balanced, the current interest rate is still too high.
“Monetary policy should be neutral, neither restraining nor boosting economic activity. Yet short-term interest rates remain far above neutral,” he writes. According to Dudley, this gap needs to be corrected swiftly, as continuing with high rates risks pushing the US economy into a deeper slowdown.
While economic data has shown some resilience, with the Atlanta Fed’s GDPNow model projecting 2.5% growth in the third quarter, the labor market has started to weaken.
Dudley points out that the unemployment rate has increased by 0.8 percentage points since January 2023, while wage inflation has moderated. This weakening labor market, he notes, could reach a tipping point. Historically, when the three-month average unemployment rate rises by more than 0.5 percentage points from its low, it has led to a recession.
Dudley believes that the 50-basis-point cut would help the Fed better align its projections with market expectations. He warns that a smaller 25-basis-point move could send mixed signals, potentially leading to confusion over the Fed’s future policy direction.
“If the Fed does only 25 now and projects another 50 at its next two meetings this year, it will send a hawkish signal,” he noted.
However, the former Fed New York president also acknowledges that the Fed might hesitate to make such a large move due to concerns over inflation. The central bank has been cautious about inflation reaccelerating, and Chair Jerome Powell is determined not to repeat the mistakes of the 1970s.
Moreover, even though the US economy has slowed a bit and the labor market has weakened, there are not many signs that it’s in or near a recession.
Nonetheless, Dudley still expects the Fed to opt for a 50-basis-point cut.
“Monetary policy is tight, when it should be neutral or even easy,” he said. “And a bigger move now makes it easier for the Fed to align its projections with market expectations, rather than delivering an unpleasant surprise not warranted by the economic outlook.”
Source: Economy - investing.com
