Federal Reserve Bank of Cleveland President Loretta Mester said on Thursday that she expects policymakers will increase the target federal funds rate beyond 5.0% as inflationary pressures continue to impact the economy.
Rate hikes increase the cost of borrowing money, lowering inflation but stifling economic activity as consumers and businesses assume less debt. Mester said in a speech before the Akron Roundtable that target interest rates, which currently remain between 4.75% and 5.0%, will “move somewhat further into restrictive territory this year.”
“We have moved interest rates up significantly over the past year and it is yielding progress. Yet demand is still outpacing supply in both product and labor markets and inflation remains too high,” she remarked. “Precisely how much higher the federal funds rate will need to go from here and for how long policy will need to remain restrictive will depend on economic and financial developments.”
Headline inflation was charted at 5.0% in March 2023, according to data from the Bureau of Labor Statistics, marking a decline from the 9.1% rate charted in June 2022. Real wages, which consider the effect of inflation on nominal pay increases, nevertheless fell 1.3% year-over-year as of March 2023, according to more data from the Bureau of Labor Statistics.
Rate hike deliberations at the Federal Reserve have been complicated more recently by the implosion of Silicon Valley Bank and Signature Bank last month, as well as broader international volatility in the financial sector. Silicon Valley Bank was forced to sell a bond portfolio at a loss because of the high interest rate environment as depositors rushed to withdraw their funds.
Mester said that the “stresses experienced in the banking system” last month have since “eased” but affirmed that the Federal Reserve will “take further steps as necessary to ensure financial stability.” She affirmed that the financial tumult would complicate policy decisions.
“Given that some of the increases in rates and tightening in financial conditions have yet to be felt in the economy, we need to be prudent in assessing all of the incoming economic and financial information when determining the appropriate path of monetary policy going forward,” she continued. “We are much closer to the end of the tightening journey than the beginning, and how much further tightening is needed will depend on economic and financial developments.”
Assets in the overall banking system are $2 trillion lower than their book value due to the elevated interest rates, according to a study from analysts at the National Bureau of Economic Research. The Federal Open Market Committee and the Federal Reserve Board of Governors predicted in a meeting last month that the volatility in the financial system warrants a recession forecast for the end of the year, followed by a recovery over the course of the subsequent two years, according to minutes released last week.
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The release of the dire prediction from Federal Reserve officials comes shortly after Treasury Secretary Janet Yellen asserted that she is “not anticipating a downturn in the economy” and after President Joe Biden claimed that his policies created a “more dynamic economy for the long haul.” Both officials have also been criticized for downplaying the severity of inflationary pressures over the last two years.