The Russia-Ukraine crisis is unfolding. With Biden threatening sanctions, what will this mean for domestic monetary policy? With the Fed’s March meeting several weeks away, Fed Governor Christopher J. Waller explained how he expects the year to unfold; starting with the obvious:
Inflation is too high, and I think concerted action is needed to rein it in.
The following day, CNBC announced the latest Personal Consumption Expenditure (PCE) reading:
Fed’s favorite inflation gauge up 5.2% for biggest annual gain since 1983.
Perhaps after seeing months of record breaking inflation statistics, Gov. Waller reiterated his position:
I am focusing most of my attention on inflation, which is far too high and needs to come down.
Fair. Now, what methods will be employed to lower inflation to a satisfactory level… according to the Fed?
Waller calls it the Appropriate Monetary Policy, which is expected to be implemented within the upcoming year. The action is slated to begin in March when the Fed will stop all new asset purchases, ending the expansion of the nearly $9 trillion balance sheet. Per the Governor, rates will finally be addressed:
Based on my outlook, my preference is to increase the target range 100 basis points by the middle of this year.
Currently the Federal Funds Effective Rate is 0.08%. To see this rate around 1% in only several months requires quite a bit of imagination; which he is anticipating.
By the summer he wants to target the 1 to 1.25% range.
As for shrinking the balance sheet, no specified time was given, but he projects no later than July. This will be much different than the last time the Fed shrunk the balance sheet, two years after the first rate hike.
Acknowledging high inflation is a problem, he goes on to say:
We constantly say we have the tools to fight inflation, and now we must demonstrate the will to use them.
The Fed seems intent on tightening, except the speed at which rate hikes and balance sheet reduction occur will be much quicker than before. The previous tightening cycle, rate hikes lasted from 2016 to 2019, before they were slashed again. The reduction on the balance sheet lasted from 2018 through 2019.
Note the last tightening cycle preceded the recession of 2020. Whether one believes this caused the 2020 recession or considers it merely coincidence depends. In any case, the opportunity to witness a causal link between tightening and recession or stock market collapse may come again. This time, the expectation is to increase rates and reduce the balance sheet within the same year.
But a lot has changed since 2016. The rate of PCE inflation, the national debt and size of the Fed’s balance sheet offers significant challenges. They say history doesn’t repeat itself, but it does often rhyme. When the next economic crisis hits, don’t expect the Fed to accept any responsibility.
