So what will the Fed do?
By tightening monetary policy, Chair Jerome Powell wants to restrain demand for labor just enough — but not too much — to bring wage growth down to the 3%-to-4% level consistent with the central bank’s 2% inflation target.
To that end, the best approach would be to hold interest rates at a moderately restrictive setting for a significant period of time. Given that rate hikes affect the economy with long and variable lags, this reduces the risk of going too far and increases the chances of a soft landing. The Fed can take its time as long as inflation expectations remain well-anchored.
But here’s the rub: It’s hard to know what a moderately restrictive rate would be. Economists can’t even agree on the threshold — the “neutral” rate that neither stokes nor cools the economy.
Before the 2008 financial crisis, they guessed that it was about 2%, adjusted for inflation (or about 4% in non-adjusted terms). Now, the median estimate among Fed policymakers is 0.5% (or a nominal 2.5%, assuming 2% inflation) — but there’s ample reason to think it should be higher as the government borrows more, the green-energy transition increases investment demand and retiring baby boomers save less.
And with inflation exceeding the Fed’s 2% target, the nominal neutral rate should be higher still.
So what will the Fed do? Most officials expect that a federal funds rate of 5% to 5.25%, maintained into 2024, will be enough to get inflation under control
Bill Dudley Bloomberg 13 februari 2023
Bill Dudley, a Bloomberg Opinion columnist and senior adviser to Bloomberg Economics, is a senior research scholar at Princeton University’s Center for Economic Policy Studies.
He served as president of the Federal Reserve Bank of New York from 2009 to 2018, and as vice chairman of the Federal Open Market Committee.
He was previously chief U.S. economist at Goldman Sachs.
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