Fed's Lacker: Inflation Has 'Bottomed Out'; Is Accelerating
Federal Reserve Bank of Richmond President Jeffrey Lacker told Bloomberg Radio host Kathleen Hays on "The Hays Advantage" today that inflation may not need to be too fast before the Fed raises the main interest rate. Lacker said, "I don't see us having to wait until inflation is actually getting to a place we don't like."
Lacker said, "We've seen inflation bottom out; I think it's pretty conclusive it's bottomed out in the last couple of quarters. And there's some tentative signs that a move back towards, a gradual move back towards 2 percent is in train, and I'm hopeful that that will play out over the year."
The following Bloomberg Radio Transcript is courtesy of Bloomberg Radio:
KATHLEEN HAYS, BLOOMBERG RADIO: We're at the Hoover Institution. Frameworks for central banking in the next century. And as you well know, rules versus discretion is a very big theme here. Lot of debate over the Taylor rule, lot of debate over what should be guiding the Fed. But there's so much -- there's so many stress, so many special factors in the economy. Do we really know enough to set rules in place that we can stick to that govern policy for this intermediate period ahead, Jeff?
JEFFREY LACKER, RICHMOND FEDERAL RESERVE BANK PRESIDENT: I think we can. I think the lesson of the academic research that's gone on on monetary policy over the last 40 or 50 years is pretty clear that, whether you formally announce a rule or point to a particular algebraic expression or not, no matter what you do, markets care about your future behavior. They're going to draw conclusions about the pattern of your behavior. They're going to think through how you're going to respond to different shocks and they're going to take that on board.
So there's a rule out there in the public's mind, in the investors -- investing community's mind whether you like it or not. And so you better be explicit about how you -- how you want them to believe you're going to respond in the future.
HAYS: Is there a rule or type of rule you prefer?
LACKER: Well, I think that the Taylor principle has been shown to be very resilient, that if inflation, inflation expectations rise, interest rates have to respond more than one for one otherwise you're lowering real interest rates while inflation's rising. And you get into a very nasty situation, as we saw in the late '70s; that was a great example of that.
So that would be a key anchor, I think, for any sensible rule.
HAYS: The Taylor rule, as John Taylor and others see it, if -- I hope I'm getting this correct, he's going to be listening to this, we better be careful, Jeff. It seems to call for higher rates now. That seems to be the message from the Taylor rule. But is there really an appetite for such a rule when most rules would suggest the Fed could be far behind the curve by the time it starts raising rates? In other words, do you really think that this -- people are kind of worried about the future still. Is that the right message to be following, the right rule?
LACKER: It's a really good question. So there's some subtleties in the rule. I mentioned the Taylor principle, how you respond to inflation. Apart from that, beyond that, how you respond to real economic developments is a tricky thing, because the economy has a certain real inflation adjusted interest rate that it wants and needs. And a central bank has to track that. And if it misses that, it's going to drive inflation the wrong way.
So that's what the rest of the Taylor rule tries to capture. And there, there's a variety of ways of parameterizing things and you get a variety of results. So you need to look at a broad range of prescriptive rules like that, and take on board what they have to say and make an assessment about just what's warranted right now.
HAYS: Central banks around the world are following virtually the same rule. We've got like roughly 2 percent inflation targeting, but except for the Bank of England, everyone seems to be falling short. Seems like this approach is failing in the U.S. and worldwide. We're not hitting those inflation targets. Does that suggest there's a global problem we can't fix with a domestic solution?
LACKER: No, I think that's premature. I don't think that's fair. I mean, we missed on the high side, 4 percent inflation a couple years ago. We're going to miss on the low side from time to time. What you want is that inflation is expected to trend back towards your target. And I think that's happening now. We've seen inflation bottom out; I think it's pretty conclusive it's bottomed out in the last couple of quarters. And there's some tentative signs that a move back towards, a gradual move back towards 2 percent is in train, and I'm hopeful that that will play out over the year.
HAYS: The affluency (ph) forecast show the medium forecast for the Fed is to raise rates to 1 percent at the end of 2015 to 2.25 percent a year later. What are your forecasts?
LACKER: Well, have to preface this. I know we sound like a broken record when we say it -- it depends on the data -- but it deserves special emphasis when you talk about what interest rates are going to do. Those point forecasts, those are the central tendency of a range of possible outcomes that committee members are looking, and I think a range of possible timing of our liftoff are possible.
HAYS: What is your forecast?
LACKER: Well, the central tendency of it would be somewhere in the middle of the next year, but it could come sooner and it could come later and it depends very importantly on how economic developments play out.
HAYS: So what is -- when you look at the economy, inflation, the likely path we're going to see in rates, is it your sense that once rates start to go up, we'll see a series of slow and kind of gradual halting increases? Or something that proceeds much more quickly?
LACKER: That's a good question and I don't think we know the answer to that. And I think it'll be interesting to see how markets react to our first increase.
We have two sort of polar cases to benchmark against. One in 1994 was one in which we were hesitant; we were -- we'd move; we'd wait; we'd move a lot; wait again. So it was a kind of a choppy path. 2004 we telegraphed our move and telegraphed the pace and pretty much stuck to it. And I think we went overboard at trying to remove uncertainty in 2004, but I think we can do better than 1994. So I'm hoping it'll be smoother than '94 but not as risky as 2004 proved to be.
HAYS: Do you think market expectations of Fed policy are appropriate now? And aligned with where the Fed is heading?
LACKER: Well, if you look at the dot (ph) picture in the summary of economic projections and listen to what the chair, Chair Yellen, has said in testimony and what presidents have said, and you look at what's in the futures curve, I think broadly speaking they're pretty well aligned right now.
HAYS: What does the sharp, unexpected drop in bond yields over the past few weeks -- a lot of people -- we talk to stock market guests all the time --
LACKER: That's a good question.
HAYS: They say, "What's the bond market telling us?" What does it mean?
LACKER: Well, it's not clear. I mean, it's the result of a decision of a broad range of investors globally. I think what's going on in Europe is clearly having some spillover effect with the anticipated easing over there. And I think that some measure of disappointment of growth expectations is occurring as well.
HAYS: You mentioned inflation, and I guess it's a question like what the bond market is seeing. Is it seeing disinflation? Is it seeing some that's even deflationary? And I think this speaks to a broader issue, for everybody on the FOMC, including you. We've seen some wages on the rise; we see some early signs that maybe inflation's heading toward the target. But, even there, the Fed doesn't see the 2 percent target reach until end 2016. And there's already a conversation about raising the key rate off zero.
Can the Fed start raising the key rate if it hasn't even reached the inflation target? Or, worse yet, if it's steady or inflation ebbs back again?
LACKER: I don't see why not. We moved rates in '94, before we saw inflation moving up. It was to nip some incipient inflation pressures in the bud, and I think that was a signal move. I think that was a very important move. The last time we tried in, in the mid '60s, we faltered. We moved but we hesitated and then inflation got away from us.
I think us doing that in '94 was really the bedrock of the success we've had since then of keeping inflation low and stable. If you look back to '94, inflation is averaged, very close to 2 percent over that whole period. And I think us moving preemptively was the key to that.
So I don't see us having to wait until inflation actually gets to place we don't like. We want to prevent that from happening.
HAYS: Is there a risk to housing if the Fed moves too soon? Or does anything -- I mean, long-term rates are so low, it's hard to imagine anything happening, right, that's going to start those yields up or push up mortgage rates, but would that be a risk? Because when people who I've interviewed and asked them about the Fed moving, maybe even doing a move off the key rate to create confidence, say, oh, but you could unsettle housing. The Fed definitely doesn't want that.
LACKER: Well, I think we should be careful not to make the mistake of treating housing with kid gloves. There's a lot going on in the housing market, a lot of adjustments in train that are really the fallout of what happened in the 2000s. I think we've got a long way to go. There's a huge stock of foreclosure inventory there, even though foreclosure starts have fallen. And there's a huge number of people that are underwater on their homes, so I think that we're far from back to equilibrium in the housing market.
So I -- it's going to play itself out with rates another half percentage point, percentage point higher, I don't think the way that market adjusts is going to be affected (ph).
HAYS: Just a couple more quick ones, Jeff. Do you think the Fed should try to shrink its balance sheet to get back to policymaking? Or can the Fed use its payments of interest on reserves, other new policy facilities to operate efficiently in the future with this very large balance sheet?
LACKER: I think the payment of interest on reserves does help us be able to operate with a larger balance sheet. But, as you know, Kathleen, I've been saying for a long time, I think the balance sheet is too large. I think that it's -- I think that it's a risk to our exist. The larger it is, the larger the risk, and I'd like to see us reduce it.
HAYS: Thank you.