Federal Reserve policymakers urging caution over interest rate hikes have gained the upper hand in the central bank’s internal debate, but the risk for the US economy is that they are wrong to downplay a recent rise in inflation.
In words that echo those of colleagues on the Fed’s dovish wing, Fed Chair Janet Yellen told a news conference yesterday that “caution is appropriate” when it comes to raising interest rates. She said she was not convinced underlying inflation had accelerated.
If Yellen is right, financial markets have ample warning for the gradual pace of rate hikes she said was likely.
But many private economists buy into the argument by an opposing faction within the Fed that U.S. inflation is indeed stirring.
They point to a range of recent data to back their view, including a reading yesterday showing underlying US inflation rose 2.3% in the 12 months through February, the biggest increase in more than three years. The Fed’s target is 2% inflation.
Faster price gains would likely trigger more aggressive rate hikes which Yellen in the past has warned could cause a recession.
“If we got to a point where the Fed had to raise (rates) quickly, it could be very destabilizing,” said Northern Trust economist Carl Tannenbaum, formerly an economist at the Chicago Fed.
Yellen’s comments sounded much like those of a vocal faction of Fed policymakers, led by Governor Lael Brainard, who have argued publicly that the global economic slowdown could knock the US economy off course. Brainard just last week counseled against assuming that a tighter labor market would boost inflation.
However, the chair’s assessment that inflation may not yet have turned the corner to a more healthy trajectory runs counter to the view of Fed Vice Chairman Stanley Fischer, who warned this month that faster inflation might well be stirring.
If Fischer is right, Fed Chair Janet Yellen may have to change her tone as soon as the next policy meeting in April.
“Yellen will have a noticeable faction of the committee that’s anxious to tighten again,” said David Stockton, the Fed’s former research director who is now a fellow at the Peterson Institute for International Economics. “They will need to be persuaded that the process is still in place, that this is not an indefinite pause.”