FEDERAL RESERVE Bank of San Francisco President Mary Daly said policy makers will likely need to raise interest rates higher and maintain them at elevated levels for a longer period of time.
“It’s clear there is more work to do,” Ms. Daly said in a speech Saturday at Princeton University in New Jersey. “In order to put this episode of high inflation behind us, further policy tightening, maintained for a longer time, will likely be necessary.”
Ms. Daly said inflation remains high in each sector — goods, housing and other services — and that the bumpy nature of incoming data paints an unclear picture for disinflation momentum. While Daly doesn’t vote on policy this year, she is a participant in Federal Open Market Committee meetings and discussions.
The Fed has tightened aggressively in the last 12 months, lifting its benchmark policy rate from nearly zero to a target range of 4.5% to 4.75%, though policymakers have recently slowed the pace of rate increases. They downshifted to a quarter-percentage-point move on Feb. 1 after hiking by a half point in December, which followed four consecutive 75-basis-point (bp) increases.
“This tightening, while pronounced, was and remains appropriate given the magnitude and persistence of elevated inflation readings,” Ms. Daly said.
During a post-speech question and answer session she discussed the potential impact of lags but made clear that the Fed could not afford to pause with inflation still too high.
“In my judgment it would be a mistake to say we’ve done all we need to do, it’s all going to be working down the road,” she said. “That’s where you have to think about continuing tightening.”
In a call with reporters following the speech, Ms. Daly repeated that she supports raising rates to somewhere between 5% and 5.5%, roughly in line with the December dot plot median of 5.1%.
Inflation, which reached a 40-year high last year, fell in the last three months of 2022, but ticked back up in January. That month’s data also showed strong consumer demand and blockbuster hiring by firms.
Ms. Daly said while it’s important to recognize the recent reversal “it is not an indicator, necessarily, that the trend has changed.”
Several of her colleagues have since said that interest rates may need to go higher than they previously thought, and investors are now betting on a peak around 5.45%. That level could be achieved by 25-bp hikes at each of the three following meetings. Ms. Daly did not specify in Saturday’s speech nor in a call with reporters afterward how much more tightening she thinks is appropriate, but told reporters that she is focused on more on the level the rate needs to get to than the pace.
“It would be enough of a preponderance of evidence that the economy is on a track that is going to require significantly more tightening that would lead me to say that we should change the pace,” Ms. Daly said. “Most of my energy right now is focused on thinking about the level at which we’ll hold.”
Policy makers will update their economic projections at their March 21-22 meeting.
Ms. Daly also spoke about the uncertainty of what will most drive future inflation. Before the pandemic, Fed officials struggled for years to get prices up to the central bank’s 2% target as an aging workforce and sluggish productivity growth weighed on inflation.
Now, new factors including the reshoring of production, a domestic labor shortage, the need for increased investment in technology and infrastructure amid a transition to greener sources of energy, and a potential change to inflation expectations could all pressure inflation upward. How these forces interact with the disinflationary ones of the past remains to be seen, Ms. Daly said.
“We don’t know what the trend will be,” Ms. Daly said. “But we do know that, while we continue to diffuse the ongoing inflation shock, we need to be working to gather data and research that illuminates the likely path forward.” — Bloomberg
