Despite his belief that the economy may avoid a recession, James Bullard, president of the St. Louis Federal Reserve, warned on Tuesday that the central bank will likely need to keep raising interest rates to keep inflation under control.
“I think that inflation has come in hotter than what I would have expected during the second quarter,” the officials from the central bank stated at a speech in New York. “Now that that has happened, I think we’re going to have to go a little bit higher than what I said before.”
Bullard said that the fed funds rate, the benchmark used by the central bank, will most likely need to increase to 3.75 percent to 4% by the end of 2022. After four rate increases this year, it now stands at 2.25 percent to 2.5 percent. The rate determines the cost that banks charge one another for overnight loans, but it also affects a lot of consumer debt products with changeable rates.
Bullard argued that the Fed’s confidence in its commitment to combating inflation will nevertheless serve it in preventing the collapse of the economy.
Bullard contrasted the current state of the Fed to the issues that early 1980s central banks had. The current rate of inflation is the highest it has been since 1981.
In contrast to the early 1980s, when Paul Volcker was the Fed’s chairman, he voiced confidence that the Fed now would not have to drag the economy into a recession.
“Modern central banks have more credibility than their counterparts in the 1970s,” Bullard said. “Because of this … the Fed and the [European Central Bank] may be able to disinflate in an orderly manner and achieve a relatively soft landing.”
Recently, markets have been betting against this scenario, predicting that a hawkish Fed will raise rates to such an extent that the economy, which has already experienced many quarters of negative GDP growth, will enter a recession. Government bond yields have been falling, and the difference between them has been narrowing. Generally, this indicates that investors are pessimistic about future economic growth.
In fact, futures pricing suggests that the Fed will need to implement rate reductions as soon as the summer of 2023 in order to offset its rate increases this year.
Bullard contended, however, that the credibility of the Fed—specifically, whether the financial markets and the general public believe the Fed has the will to stop inflation—resides in large part in its ability to direct the economy toward a gentle landing. He made a distinction between it and the 1970s, when the Fed raised rates in response to inflation but soon reversed course.
“That credibility didn’t exist in the earlier era,” he said. “We have a lot more credibility than we used to have.”
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