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In August 2020, the Federal Reserve adopted a new framework that made clear the central bank wouldn’t raise its benchmark interest rate until inflation rose so that it averaged 2% over time, to make up for years when inflation was under that level.
At the time, economists thought this goal was a very high hurdle, but the surge of the costs of myriad goods and services over the past year has resulted in that inflation target having cleared this hurdle, said Cleveland Fed President Loretta Mester on Thursday.
“Our new strategy says, look, we’re not going to be moving until we have average inflation being 2% and we’re now going to be making up for past misses. I think we’ve basically met that part of the mandate,” Mester said, during a discussion sponsored by the European Central Bank.
The Fed’s new framework also called for the economy to reach a broad-based and inclusive goal of “maximum employment” before the central bank would engineer a liftoff in rates.
This part of the Fed’s mandate has not been met, Mester said.
“My forecast is that we’ll meet that [employment] mandate by the end of next year, if things play out as I expect,” Mester said.
Other Fed officials may have differing views. Mester will have an important voice in the debate as a voting member of the Fed’s interest-rate committee next year.
During the ECB panel discussion, Mester said much of the increase in inflation this year has been driven by components tied to the coronavirus pandemic.
“My baseline is we’ll see inflation rates move back down as pent-up demand eases and supply-side challenges ease. But, as you know, that is taking longer than people thought and, in some cases supply chain issues are getting worse,” Mester said.
The Cleveland Fed president said the risks of inflation moving up are larger than the chances that it will move lower.
A continued rise in inflation that’s accompanied by an increase in medium-term inflation expectations, Mester said, would signal to her that “the demand-side factors” pushing up prices are stronger than thought and inflation is not just being driven by supply-side issues related to the pandemic.
“Indeed, the only way for those things to continue to increase is its coming from the demand side and policy would have to react,” she said.
“At this moment, I don’t see that as being the baseline, but I’m attuned to those risks,” she said.
The yield on the 10-year Treasury note
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has moved steadily higher since the Fed’s last meeting in late September.
