Senior Fed official calls for higher rates that start to stunt US economy

A senior Federal Reserve official has called for the US central bank’s main interest rate to rise to a level at which it starts to stunt economic growth by the end of the year, brushing off concerns that a sharp monetary tightening would hurt the labor market.

In a speech at Goethe University in Frankfurt, Germany on Monday, Christopher Waller, a Fed governor, said he backed increasing interest rates by another 50 basis points “for several meetings” and would not stop that pace “until I see inflation coming down closer to our 2 percent target”.

“By the end of this year, I support having the policy rate at a level above neutral so that it is reducing demand for products and labour, bringing it more in line with supply and thus helping rein in inflation,” Waller said.

The Fed does not specify an exact figure as the “neutral” rate, the point at which monetary policy neither boosts nor stunts economic activity. However, central bank officials forecast interest rates will settle at 2.4 per cent over the long run, a good approximation for the “neutral rate”.

Waller said his expectations were roughly in line with those of investors in financial markets, who are predicting the policy rate to hit 2.65 per cent by the end of the year.

“If the data suggest that inflation is stubbornly high, I am prepared to do more,” he said.

Top Fed officials have said they were prepared to increase interest rates above the “neutral” level if needed, but Waller has gone slightly beyond that by saying this should now be the goal of the Fed.

Waller said it was crucial for inflation expectations to remain in check. “What I care about is getting inflation down so that we avoid a lasting escalation in the public’s expectations of future inflation. Once inflation expectations become unanchored in this way, it is very difficult and economically painful to lower them,” he said.

He also sought to dismiss fears that steep interest rate rises along the lines he is advocating would deliver a substantial hit to the jobs market and possibly trigger a recession.

“The unemployment rate will increase, but only somewhat because labor demand is still strong — just not as strong — and because when the labor market is very tight, as it is now, vacancies generate relatively few hires,” Waller said. “Thus, reducing vacancies from an extremely high level to a lower — but still strong — level has a relatively limited effect on hiring and on unemployment.”

Waller, a former senior economist and official at the St Louis Fed, is seen as a relatively hawkish Fed governor. His comments come as central bankers debate the best way to reduce inflation without excessively harming economies, and Waller’s argument is that the Fed should not be too wary of the negative impact of higher rates on jobs.

“Of course, the path of the economy depends on many factors, including how the Ukraine war and Covid-19 evolve. From this discussion, I am left optimistic that the strong labor market can handle higher rates without a significant increase in unemployment,” he said.

Waller also gave a nod to transatlantic cooperation, both with regards to the war in Ukraine and the fight against inflation.

“Europe and the US have strengthened our ties and I believe we are more unified today than we have been for decades. We see that in the deepening and possible broadening of our security commitments, and we also see it in the strong commitment that central banks in Europe and elsewhere have made to fight inflation,” he added.

Meanwhile, Jay Powell, in the Fed chair, is scheduled to hold a relatively rare meeting with Joe Biden on Tuesday at the White House, in a sign of how worried the US president is about soaring inflation and the consequences for his Democratic party at midterm elections in Nov.