In the 1970s and 1980s, Federal Reserve policy often caused recessions to get inflation down. It might not have to take such draconian steps this time, said Chicago Fed President Charles Evans on Friday.
In this cycle, inflation gains have been largely driven by unusual supply-side developments related to the Covid-19 shock, and underlying inflation remains contained, Evans said, in remarks to the U.S. Monetary Policy Forum, organized by the Chicago Booth Initiative on Global Markets.
“So—unlike in the Volker and Greenspan eras—no extra monetary restraint is needed to bring trend inflation down,” Evans said.
Evans is not a voting member of the Fed’s interest-rate committee this year. He has been the president of the Chicago Fed since 2007, making him the longest service Fed regional president. A long-time proponent of allowing the economy to run hot, Evans made fun of himself, saying that his remarks were “typical Evans dovishness.”
Despite this stance, Evans said he agreed that the Fed has to start raising interest rates this year, given the high inflation readings..
“I agree the current stance of monetary policy is wrong-footed and needs substantial adjustment,” he said.
In his remarks, Evans focused on how high interest rates may have to go..
At the moment, the Fed’s policy rate is close to zero. By its own estimation, the Fed will have to get its policy rate up to 2.5% before it is “neutral” – neither boosting growth or restraining demand.
It is the decision to go beyond neutral, which would restrain demand and thus potentially causing a recession – that former Fed chairs Volker and Greenspan both made.
They were facing rising cyclical inflation and underlying inflation, Evans said.
Their “two-fisted restrictiveness led to recessions and high unemployment—sometimes intentionally and sometimes because the already moderating economy was subsequently hit by unexpected shocks,” Evans said.
That is not the case this year, he added.
The fact that the “relative” price gains were caused by COVID “may be different from more typical cyclical inflation episodes. Furthermore, by my reading, underlying inflation appears to still be well anchored at levels consistent with the Fed’s average 2 percent objective, and so—unlike in the Volker and Greenspan eras—no extra monetary restraint is needed to bring trend inflation down,” Evans said.
A relative price increase is a one-off gain, not a persistent trend.
“So I see our current policy situation as likely requiring less ultimate financial restrictiveness compared with past episodes and posing a smaller risk to the employment mandate than many times in the past,” Evans added.
The Fed will watch the inflation picture closely, Evans said.
If there are signs that cyclical inflation is bleeding into underlying inflation, than a more restrictive policy may be warranted, he said.
After moving above 2% this month, the yield on the 10-year Treasury note
has fallen below 1.95% on fears of a looming Russian invasion of Ukraine.