MNI INTERVIEW: Fed Facing Stagflation Risk- Ex-NY Fed Adviser

Rising goods inflation due to tariffs will soon put the Federal Reserve in the uncomfortable position of having to hold rates steady despite weaker economic growth, former NY Fed policy adviser John McGowan told MNI. 

“I am really concerned about cost-push inflation,” McGowan said in an interview.  “I really hope they lean toward lower future inflation, take the economic medicine now, focusing on the stable price mandate. What I fear the most is a little bit of a pre-emptive rate cut amid rising inflation – that would stoke inflationary expectations.”

McGowan said those expectations are still fairly well contained despite recent spikes in the short-term inflation views of consumers in key sentiment surveys. 

“I don’t think they are unanchored. But we’re not far from it,” he said. 

While he does not have a specific forecast as to how much of an inflation resurgence will take place because of tariffs, McGowan expects it will be significant.

“The equilibrium is going to be higher prices and lower quantities. This is going to happen in two months, maybe six weeks," he added.

Fed officials have said they are keeping the federal funds rate on hold for now at 4.25-4.5% as they wait for greater clarity on whether the bigger effect of the White House trade and immigration policies will be a boost to inflation or a hit to growth. (See MNI INTERVIEW: Fed Cuts Start In Q4 As Tariffs Weigh -Crandall)

“I’m worried about the prospect of stagflation, and I think we need to tolerate that for a period of time, let’s say two or three quarters, assuming the goods inflation materializes. And how could it not?” he said, adding that it will be important to watch wage growth for signs of inflation persistence. 

“That's sort of the definition of cost-push inflation. The cost of everything goes up and it's not a one-time bid because the wages now start tracking.”

RESERVE CURRENCY

McGowan worries the Trump administration appears to resent rather than appreciate the value of the dollar’s reserve currency, which he said bring countless benefits to the American economy ranging from lower interest rates to flight-to-safety bids in times of stress. (See MNI INTERVIEW: FX Deal, Treasury Fee Not On Trump Agenda-Miran)

“The president of the United States underappreciates the value of having the world’s receive currency.  He's going out of his way to lessen the market’s perception that the dollar is the world's reserve currency,” he said.

“It’s very concerning. There’s a lot of implicit benefit that the country gets from being the reserve currency, it helps with interest rates and it helps with foreign exchange.”

STAYING AMPLE

McGowan, who spent 24 years at the New York Fed and did a lot of work on the Fed’s operating framework, said the benefits of an ample reserves regime – including ensuring a repeat of the 2019 repo freeze does not happen – outweigh any costs associated with a larger balance sheet. 

“Sure, it's a little inefficient to have the balance sheet to be larger than it should be and sure there's a cost to that, because it's losing money right now,” he said. “But in terms of the efficiency of the framework, there isn't much of a cost.”

He does not believe the Fed will go back to a scarce reserves framework despite what he called some nostalgia for the old days.

“This framework is just different. It’s just not going to happen,” he said.