Dallas Federal Reserve President Lorie Logan has cautioned against the risks of tightening monetary policy too little or raising interest rates too much. Speaking at Prairie View A&M University, Logan emphasized that the most critical risk is not doing enough to keep inflation in check, which could lead to a self-fulfilling spiral of unanchored inflation expectations.
The second risk, according to Logan, is tightening too much or too fast, which could weaken the labor market and cause job losses, particularly affecting lower-income households. Logan, who is a voting member of the Fed’s interest rate committee this year, urged for a cautious approach to raising interest rates.
Avoiding a Self-Fulfilling Spiral of Unanchored Inflation Expectations
Logan emphasized that the Fed must continue gradually raising the benchmark Fed funds rate until there is “convincing evidence” that inflation is on track to return to the Fed’s 2% target. She warned that failure to do so could trigger a self-fulfilling spiral of unanchored inflation expectations, which would be very costly to stop.
To avoid such a scenario, Logan believes that the Fed should gain confidence in its outlook for the economy. However, she acknowledged that confidence in the forecast is in short supply, particularly when jobs reports show unexpectedly high job gains, as was the case in January when the economy added 517,000 jobs.
No “Locking In” on Peak Interest Rates
Logan also spoke against the notion of “locking in” on a peak interest rate or a precise path for the rise in rates. Instead, she advocated for a more flexible approach that allows for adjustments based on economic conditions.
U.S. Stocks Volatile After CPI Report
The January consumer price inflation data, released earlier this month, has caused some volatility in U.S. stocks. The Dow Jones Industrial Average and the S&P 500 were trading lower on Tuesday, with the yield on the 10-year Treasury note rising by 8 basis points to 3.79%.
As the Fed grapples with the risks of tightening monetary policy, Logan’s caution against unanchored inflation expectations and the need for a gradual rise in interest rates is a timely reminder of the delicate balancing act the Fed must perform. With the U.S. economy showing signs of resilience despite the ongoing pandemic, the Fed’s decisions will continue to have a significant impact on the economy and financial markets.