Fed Speeches Highlight Fault Line In Rate Debate

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Speeches Tuesday by two influential members of the Federal Reserve highlight the fault line that exists within the central bank even as Fed officials appear poised to raise interest rates at their next meeting in December.

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Richmond Fed President Jeffrey Lacker made the case for why rates should start moving higher immediately, while Chicago Fed President Charles Evans argued for further delay until inflation is clearly moving higher toward the Fed’s 2% target.

Lacker, the lone dissenter in last month’s vote by the policy-setting Federal Open Market Committee (FOMC) to hold off on a rate hike, said in a speech in Washington, D.C., that recent inflationary trends “bolster the case for raising the federal funds rate target now.”

Evans, in a speech entitled “A Cautious Approach to Monetary Policy Normalization” given in Chicago, said, “before raising rates, I would like to have more confidence than I do today that inflation is indeed beginning to head higher.”

It’s no secret that the FOMC has long been divided by inflation hawks and doves, with the hawks favoring higher rates and the doves backing the status quo of near-zero rates until it’s clear the economy can absorb the higher borrowing costs that will follow liftoff.

Lacker has long been a member of the former, but that group has been a minority, overruled by the doves led by Fed Chair Janet Yellen, Vice Chair Stanley Fischer and New York Fed President William Dudley.

Lacker may finally move into the majority in December, as Yellen, Fischer and Dudley have all made clear in recent speeches that they support raising rates before the end of the year. The Fed meets for its final 2015 two-day meeting on Dec. 15 and 16.

Indeed, Yellen made a point of telling a Congressional committee last week that raising rates at the December meeting was a “live possibility.”

In a speech heavy on economic theory, Lacker made the case that the Fed (and other central banks) can have a significant influence on inflation – or price stability – through setting interest rates, but that their influence on economic activity is less direct.

“In contrast, monetary policy’s ability to affect real economic activity – when monetary policy is being reasonably well-executed – can be quite limited and is almost always short-lived,” Lacker said.

In any case, he argues that moving rates higher won’t act as an impediment to the inflation rate moving upwards towards the Fed’s 2% target.

Evans, meanwhile, expressed skepticism that inflation would move higher at the relatively swift rates predicted by many of his Fed colleagues. Given the “headwinds” from low energy prices and a strong dollar could hold inflation below, Evans said it could be “well into next year” before evidence suggests inflation is moving upward toward the 2% target.

Other Fed economists have predicted a much sharper upward trajectory for inflation.

Evans and Lacker (as well as all members of the FOMC) agree on one thing: that the upward trajectory of rates after initial liftoff should be gradual.

“After liftoff, I think it would be appropriate to raise the target interest rate very gradually. This would give us sufficient time to assess how the economy is adjusting to higher rates and the progress we are making toward our policy goals,” Evans said.

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