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.”
Fed’s Lacker: Can Raise Rates Before Inflation Rises
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?
Fed’s 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?
Fed’s 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?
Fed’s 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?
Fed’s 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?
Fed’s 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?
Fed’s 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?
Fed’s 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?
Fed’s Lacker: Well, if you look at the dot (ph)