The Federal Reserve just started raising interest rates, but the big question now is how much longer officials will continue tightening monetary policy. The answer, it seems, depends not only on the trajectory of inflation, but also the composition, according to Chicago Fed President Austan Goolsbee.
The Federal Open Market Committee raised the Fed funds range to 3.75% to 4% at the conclusion of last week's policy meeting. The tighter monetary policy is aimed at more speedily returning inflation to the Fed's 2% target.
Goolsbee told reporters Monday that he supported the rate increase. He isn't currently a voting member of the FOMC this year, but will be one next year. The latest summary of economic projections showed that FOMC officials see one additional rate increase on tap for this year, but no further rate increases next year.
But to determine when it will be appropriate to stop further rate increases, Goolsbee said he is monitoring not just at how fast inflation is cooling down, but also how specific components are behaving. If services inflation, for example, remains firm or even starts to creep higher, Goolsbee says that would be would make him "uneasy"-even if the aggregate rate cools. In the August consumer price index, services rose 0.3% month over month, up from a 0.2% gain in July. Services inflation is up 3% over the past year.
As for determining when inflation is heading sustainably back to the Fed's 2% target, Goolsbee says he's watching both the details and the overall pace. The June CPI report, he said, is a good example of what he's looking for: Services inflation was flat and headline price growth cooled.
If there are several inflation reports where aggregate price growth remains steady or even rises, that would unquestionably argue for further hikes in the near term, Goolsbee said.
Complicating the issue, however, is the fact that the Bureau of Economic Analysis is updating the methodology around how it calculates the inflation gauge tied to the Fed's 2% benchmark-the personal consumption expenditures, or PCE, price index-on Sept. 30. Economists expect the changes to result in slightly lower readings of the PCE price index for August.
But even with the changes, economists expect PCE inflation rose 0.3% month over month in August, an acceleration from July's 0.2% pace. PCE inflation is expected to measure 3.7% year over year in August, the same pace as July. Core PCE inflation, which strips out volatile food and energy prices, is similarly expected to remain steady, according to FactSet.
As supply shocks prove more frequent and persistent, simply looking through the effects won't work, Goolsbee added Monday. "These days, when you see a large supply shock, it's usually more accurate to assume it will be persistent than to assume it will quickly go away. That's certainly been the U.S. experience over the last six years," Goolsbee said.
Covid-19 supply chain disruptions, for example, were supposed to unwind within months, but it took much longer. Or when war broke out in the Middle East, futures markets projected oil prices to fall rapidly, Goolsbee said. But months later, oil is still around $100 a barrel and potentially heading higher.
Goolsbee said Monday that he's currently "especially attuned" to elevated inflation in service-sector industries-as well as any evidence that shows the buildout of artificial-intelligence capabilities, including data-center construction, is "spilling out of its own lane and raising aggregate output beyond what the economy can absorb."
Either of those things could be signs of "old-fashioned demand overheating," which is likely to lead to higher persistent inflation levels, he said.
"Our policy response to persistent supply shocks may not need to be as large as it would be if the inflation were coming from demand overheating. But it won't be painless either. This is exactly the painful trade-off between employment and inflation that stagflationary shocks always impose on a central bank," Goolsbee said.
Unfortunately, in environments like that, Goolsbee said the only way back is the "hard way."
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