Fed official: It’s ‘fantasy’ to think modest rate rises will tame inflation

A top Federal Reserve official has warned it is a “fantasy” to think the US central bank can bring inflation down sufficiently without raising interest rates to a level where they constrain the economy.

James Bullard, president of the St Louis branch of the Fed, said the central bank needed to be more aggressive in its efforts to root out the highest inflation in four decades as he called for rates to rise to a point where they actively curtail growth.

The comments from Bullard, a voting member of the policy-setting Federal Open Market Committee and one of its foremost hawks, run counter to other officials, who are broadly aligned on the need to push rates closer to a “neutral” level this year.

That is the level at which rates neither fuel nor restrict economic activity and is estimated to be around 2.4 per cent. Bullard said the central bank would need to get beyond that threshold as quickly as possible this year if it wanted to bring inflation closer to the Fed’s longstanding 2 per cent target.

“There’s a bit of a fantasy, I think, in current policy in central banks,” Bullard said in an interview with the Financial Times. “Neutral is not putting downward pressure on inflation. It’s just ceasing to put upward pressure on inflation.”

“We have to put downward pressure on the component of inflation that we think is persistent,” he added. “Getting to neutral isn’t going to be enough it doesn’t look like, because while some of the inflation may moderate naturally . . . there will be a component of it which won’t.”

His comments come on the heels of new inflation data that showed consumer prices increased at an annual rate of 8.5 per cent in March following a surge in energy and fuel costs driven by Russia’s invasion of Ukraine.

“Core” inflation, which strips out volatile items such as food and energy, came in slightly lower than expected, but Bullard warned it would not come down without a concerted effort from the Fed and that the US was vulnerable to unforeseen shocks that could further stoke prices.

“This [inflation] report just underscores the urgency that the Fed is behind the curve and needs to get moving,” he said.

A separate report on Wednesday showed further evidence of broadening inflation as prices paid to US producers climbed 11.2 per cent in March, the quickest pace since the year-on-year rate was first calculated in 2010.

Bullard supports the Fed raising rates by half a percentage point at the next policy meeting in May, something he urged the FOMC to do at its gathering in March, when it raised them by a quarter-point.

More officials now back such a move, as well as a reduction in the size of the Fed’s $9tn balance sheet soon.

He said the Fed’s benchmark policy rate should move up “sharply” after the May meeting and endorsed a 3 percentage point increase in the federal funds rate from its current range of 0.25 per cent to 0.50 per cent by the third quarter.

Bullard acknowledged that such a level was “aspirational” in such a short period of time, but warned the Fed’s credibility would be on the line if it did not take action.

“If markets and households get the idea that the Fed’s not going to do the right thing and not going to keep inflation under control, then you have to gain credibility by actually doing things that show them that you are serious,” he said.

Bullard pointed to former Fed chair Paul Volcker’s decision to raise rates to 20 per cent at one point in the early 1980s, which did contain inflation but resulted in a sharp economic contraction that resulted in millions of job losses. Volcker had no choice other than implementing such a large increase “because the committee didn’t have enough credibility”, Bullard added.

“So far I think we’re holding on to our credibility, but if it slips away, then it’s going to be much more difficult to keep inflation under control going forward.”

Still, Bullard said he was optimistic the Fed would be able to cool down the economy without causing a recession — as it did in 1994.