Federal Reserve officials should adjust their policy statement to reflect the possibility that the next rates move could be either up or down, particularly with inflation kept aloft by the Iran war and other shocks to global supply chains, former Fed Board economist Fabio Natalucci told MNI.
“They should start communicating that hiking is a possibility. You can start with providing a more symmetric outlook for policy rates. Getting rid of the word ‘additional’ would be an easy low-hanging fruit in my mind,” Natalucci, also a former senior IMF official and now director of the Andersen Institute, said in an interview.
The Fed’s current statement refers to policymakers “considering the extent and timing of further adjustments,” a phrase seen as still indicating that the next rate change would be a reduction.
“I just can’t imagine how you can possibly cut interest rates here,” Natalucci said.
He is concerned that repeated economic shocks like the U.S. trade war and now the war in Iran are part of a pattern of increased global fragmentation that is inherently inflationary. He’s also worried about the stability of inflation expectations after five years of above-target inflation. (See MNI INTERVIEW: Iran Risks Tilt Toward Persistent – Ex-Fed Evans)
“Any shock that hits you when you are that far from the target just kind of takes you even farther away from the target,” he said. “There is this entire rethinking of the supply chain to make them more resilient. All of these combined introduce costs, make the system moving away from just in time and efficiency to really about resiliency, just in case.”
Price Mentality
He thinks a period of prolonged inflation has made consumers more accustomed to price increases and companies more willing to push them through.
“The reluctance that we saw pre-Covid to raise prices, that mentality is changing a little bit,” Natalucci said. “You can slice data wherever you want. Everything is pointing to an acceleration.”
And even if the Iran war ends today, shortages of energy and other basic goods caused by the closure of the Strait of Hormuz will linger, he said.
While the advent of AI could eventually lead to a productivity boom that brings down inflation, the surge in chip demand and data center capex is actually putting upward pressure on prices, Natalucci said.
“The data center capex, the new demands for chips, demand for memory, all of that notwithstanding the medium- to longer-run impact on productivity, seems to be adding to inflationary pressure,” he said.
Warsh Fed
Natalucci said he would welcome changes to the Fed’s communications approach, which new Fed Chair Kevin Warsh has criticized for being cacophonous and for using forward guidance that he sees as unduly binding. The best way to move away from this, said Natalucci, is to more avidly embrace the kind of scenario analysis that keeps the central bank’s options open.
“My preference has always been for scenarios. I think the urgency of scenarios is even more evident in the current environment of huge uncertainty,” he said.
“The SEP discussion, the dot plots, all that stuff probably would take longer to do. You don’t have to scrap the SEP. I think you could downplay the SEP. The easy way would be to not publish the SEP the day of the press conference, and maybe release them with the minutes.”
Balance Sheet
Warsh, who has been a critic of the Fed’s large balance sheet, could also seize the chance to further clarify the role of asset purchases in the central bank’s menu of policy options, according to Natalucci. (See MNI POLICY: Fed Prepares Balance Sheet Options For Warsh)
“The Fed could have done a better job of communicating balance sheet policies in terms of objective, size, composition. How to think of QE versus lender of last resort, when you buy for QE or when you buy for financial stress?” he said. “I think there’s another opportunity to come up with a clean balance sheet policy, putting in place at least some principles of size, composition.”
A version of this story appears on MNI’s website.
