Bill Dudley, the former president of the Federal Reserve Bank of New York, cautioned that the central bank’s approach to managing inflation risks recession.
Dudley, who helmed the New York Fed from 2009 to 2018, sounded the alarm about the Fed’s policy in an op-ed published on Monday by Bloomberg. He said that the new Fed policy announced last summer, which targets 2% inflation but allows that figure to be breached, “makes a lot of sense.”
“But, unfortunately, the way the Fed is putting this long-term monetary policy framework into practice is likely to result in more volatile interest rates and more risk of recession,” Dudley continued.
Dudley, who also served as vice chairman of the Federal Open Market Committee that sets the central bank’s interest rate target, said that the problem with the Fed is that its new strategy has been put into practice in an “unnecessarily extreme way.” He pointed out that the Fed wants to hold interest rates at near-zero until there is maximum employment, inflation reaches 2%, and inflation is expected to remain above that level for some time.
YELLEN WALKS BACK COMMENTS ON INFLATION RISING
“This means monetary policy will remain loose until overheating begins — and cooling things off will require the Fed to increase interest rates much faster and further than it would if it started raising rates sooner,” he said. Dudley cautioned that the result will be increased volatility in short-term rates and an increased likelihood of an “economic hard landing.”
“The delay in lifting off, for example, is likely to push the unemployment rate considerably below the level consistent with stable inflation, increasing the odds that the Fed will need to tighten sufficiently to push the unemployment rate back up by more than 0.5 percentage point,” Dudley wrote. “Over the past 75 years, every time the unemployment rate has moved up this much, a full-blown recession has occurred along with a much more substantial increase in the unemployment rate.”
The former Fed president said that the new policy framework about inflation doesn’t require the central bank to take such big risks. He said that instead, officials could put in place conditions that allow the Fed to begin raising interest rates “sooner and more gradually” without conflicting with its 2% inflation goal. Dudley warned that while the current strategy might be attractive now given the economic recovery from the COVID-19 pandemic, it “will come at a potentially high cost later — a tradeoff to which the Fed should be paying greater attention.”
Dudley’s op-ed comes after Treasury Secretary Janet Yellen said that the U.S. could see inflation rates at about 3% through the rest of the year. She also said that it would be a plus for society’s point of view and the Fed’s point of view if the country ends up with a slightly higher interest rate environment, although she tried to walk those remarks back during a flight back to the U.S. from London, where she was meeting with the G-7.
Yellen said that while she thinks inflation will likely be high for the next few months, it will settle back down to the Fed’s 2% target. “I don’t see any evidence that inflation expectations are getting out of control,” she said.
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The Commerce Department recently said that a key inflation indicator rose from a yearly pace of 3.1% in April, topping the predicted rise by 2.9%. The Department of Labor also announced that consumer prices rose 4.2% for the year ending April, with increased costs across the board. The rate of inflation was the highest since 2008.
