By Howard Schneider
WASHINGTON (Reuters) – The strength of the U.S. housing market and potentially stalled progress on inflation means monetary policy may not be as tight as Federal Reserve officials think it is, Minneapolis Federal Reserve President Neel Kashkari said in a new essay on Tuesday that raises the possibility price pressures are “settling” to a level above the Fed’s 2% target.
Wrongly estimating how current policy is affecting the economy “could explain the constellation of data we are observing,” particularly in housing but more broadly in ongoing economic growth, Kashkari wrote. Housing in particular is “proving more resilient to…tight policy than it generally has in the past,” depriving the Fed of what is typically a key channel for the impact of high interest rates to be felt.
Kashkari said that could be happening for a number of reasons, from blunt ones like a housing supply shortage coupled with rising demand, to a more difficult-to-diagnose shift in the “neutral” rate of interest which would imply that Fed policy is not restricting the economy as much as expected.
Regardless, it means the Fed has to determine whether inflation has truly stalled above target or whether price pressures will eventually continue to ease – a key issue that could force policymakers to decide whether it is worth risking a recession with even tighter monetary policy in order to squeeze a few tenths of a percentage point from the pace of price increases.
“The question we now face is whether the disinflationary process is in fact still underway, merely taking longer than expected, or if inflation is instead settling to around a 3% level, suggesting that the (Federal Open Market Committee) has more work to do to achieve our dual mandate goals,” Kashkari wrote.
Kashkari did not settle on an answer or update his views on the proper path of monetary policy. Prior to the Fed’s last meeting he said that disappointing inflation data and ongoing growth might mean the Fed does not cut interest rates at all this year, but that further increases in the benchmark policy rate were “not a likely scenario.”
MOVING SIDEWAYS
The U.S. central bank at its meeting last week kept the benchmark policy rate steady in a range of 5.25% to 5.5%, where it has been since July, with officials generally resetting expectations for a later start and less overall policy easing this year. Fed officials will provide more specific guidance on that at their June 11-12 meeting when they issue new quarterly economic projections.
As of March the Fed’s preferred inflation measure, the personal consumption expenditures price index, was increasing at a 2.7% annual rate.
It’s a number which, at one and the same time, represents a marked drop from the more than 7% rate seen during a breakout of inflation in 2022, remains too high for policymakers to say their job is finished, yet is close enough to 2% that there may be reluctance to raise interest rates further and risk the sort of rise in joblessness policymakers have hoped to avoid.
At his press conference following last week’s meeting, Fed Chair Jerome Powell said that in a situation where the job market remains strong but inflation is “moving sideways,” the Fed would likely just hold off on rate cuts and wait since policymakers still believe the current benchmark interest rate is adequate to achieve the Fed’s inflation goal.
Kashkari raised a different possibility: That for various reasons, perhaps even temporary ones, the “neutral” rate of interest has risen, which means the economy will remain stronger than it has in the past under the same monetary policy.
“With inflation in the most recent quarter moving sideways, it raises questions about how restrictive policy really is,” Kashkari wrote. “The uncertainty about where neutral is today creates a challenge for policymakers.”
