Analyst: The Fed needs to tighten monetary policy

According to Analyst Bill Dudley, the reason for the Fed to tighten monetary policy remains strong, regardless of how high-frequency data fluctuate. First, in view of the asymmetries between the current economic situation and the two objectives of the Federal Reserve to achieve full employment and price stability, a tight monetary policy is appropriate. On the one hand, the unemployment rate has remained stable and very close to what the members of the Federal Open Market Council consider to be a level of full employment; on the other hand, inflation remains high, with core inflation indicators ranging between 2.4 and 3.3 per cent. In such cases, monetary policy should be austerity measures. Second, there is little evidence of a tightening of current monetary policy. Federal funds interest rates have remained at current or higher levels for almost four years, unemployment rates have remained fairly stable and have been at full employment levels for the past two years. If the policy is really tight, then in theory it should be seen that unemployment is rising and inflation is falling. The current strong financial market conditions also support this judgement. Thirdly, the AI investment boom also supported further tightening of monetary policy. The surge in AI spending is driving real GDP growth and pushing up prices in a number of areas, such as electricity costs and the price of semiconductor chips. While AI is expected to raise productivity and help reduce inflation in the long run, the prevailing role remains to stimulate demand and push prices up. Fourthly, the credibility of the Fed is at risk. Inflation has exceeded the Fed's target of 2 per cent for more than five consecutive years. If the Fed hesitates, market participants may think that Walsh's hard-line rhetoric is “a bluff”. The Fed should not tighten monetary policy simply to enhance its credibility against inflation. But the reality is that the Fed faces asymmetrical risks: In the coming years, if monetary policy is not sufficiently restrained to bring inflation back to 2 per cent, the costs will be higher than the costs of a slightly more restrictive policy and a posteriori proof of excessive tightening. Walsh has been high-profile in his commitment to achieving price stability and preserving the Fed’s independence, but action is far more convincing than words. While the establishment of working groups and the introduction of new ideas were positive, monetary policy could not be outsourced to outside experts or financial market participants. The Fed needs to step up its efforts to tighten monetary policy. Bill Dudley expects that the Fed will maintain monetary policy at its meeting next week, but by the fall the pressure to tighten monetary policy will be enormous. (KIM XAPP)