MNI BRIEF: Fed's Hammack - Cuts Could Prolong Inflation Fight

Federal Reserve Bank of Cleveland President Beth Hammack on Thursday said lowering interest rates risks prolonging elevated inflation, and could come at the cost of heightened financial stability risks down the road. 

"Inflation has been running above the Fed’s 2% objective for four and a half years. Lowering interest rates to support the labor market risks prolonging this period of elevated inflation, and it could also encourage risk-taking in financial markets," she said in prepared remarks for a financial stability conference. Financial conditions are quite accommodative today, reflecting recent gains in equity prices and easy credit conditions, she said. 

"Easing policy in this environment could support risky lending. It could also further boost valuations and delay discovery of weak lending practices in credit markets," Hammack said. "This means that whenever the next downturn comes, it could be larger than it otherwise would have been, with a larger impact on the economy. At that point, policy would have less space to further reduce rates and offset weak demand." 

Some Fed officials have taken to describing recent rate cuts as insurance for a cooling labor market. Hammack said sometimes cutting rates is described in risk-management terms as taking out insurance against a more severe slowdown in the labor market. "But we should be mindful that such insurance could come at the cost of heightened financial stability risks," she said. (See: MNI INTERVIEW: Private Credit Poses Systemic Risks - Ghamami) 

"There’s already a substantial body of research on how persistent inflation can increase risks for banks and put pressure on household finances."