Federal Reserve Bank of Kansas City President Esther George said the Fed should quickly move to a neutral monetary policy setting due to decades-high inflation readings and near-record low unemployment.
Speaking virtually March 30 to The Economic Club of New York, George noted that the Fed’s monetary policy is “out of sync with the state of the economy,” and “likely as accommodative as it has ever been at a time when inflation is well above the Fed’s target and labor markets are tight.” Earlier in March, the Federal Open Markets Committee raised interest rates to 0.25 percent to 0.5 percent, a move George supported, and signaled it will soon reduce its approximately $9 trillion balance sheet to bring down inflation.
George said moving to a neutral monetary policy should still be responsive to risks, “the responsiveness of activity to interest rate changes, and yield curve developments.” She added that her approach takes into consideration supply chain shortages worsened by the ongoing pandemic disruptions in Europe and Asia and impacts from the war between Russia and Ukraine.
“In the event high inflation persists while demand turns down, and the labor market falters, policymaker resolve could be tested,” George noted. “If the assumption of temporary pandemic effects on supply and demand proves to be overstated, and the imbalance between strong demand and lagging supply persists, the potential to dislodge inflation expectations and price-setting dynamics will further complicate policymakers’ task.”
Though a flat or inverted yield curve is a possible indicator of a recession, George’s main concern comes through the possible implications for financial stability. “An inverted yield curve also pressures traditional bank lending models that rely on net interest margins, or the spread between borrowing short and lending long,” she said. “Community banks in particular rely on NIM to maintain their profitability, with rural areas especially dependent on community banks.”
A significant part of George’s address described the quick economic shutdown and recovery from the pandemic. Personal income has increased at a faster rate since 2020 than any other two-year period in the past 15 years, which George attributed to stimulus checks, enhanced unemployment benefits, and the rapid recovery in the labor market. Today, households hold more than $2 trillion in additional savings compared to pre-pandemic trends, placing them in a good position to spend. This has fueled high demand, which, along with depressed supply and a tight labor market, has driven inflation readings to their highest readings in decades. Still, there are signs that inflationary pressures are easing: The New York Fed’s index of global supply chain pressures fell noticeably in the first two months of this year, and inventories rose faster at the end of 2021 than at any time since 2015.