MNI INTERVIEW: Fed In Easing Territory After Rate Cuts - Tracy

U.S. monetary policy has crossed into accommodative territory after three straight rate cuts, further imperilling the Federal Reserve's price stability objective and inflation-fighting credentials, Joe Tracy, former executive vice president and senior adviser to the president at the Dallas Fed, told MNI. 

In prioritizing the full employment side of its dual mandate, the central bank is also poised to deliver more cuts that the Trump administration has loudly called for, highlighting the difficulty of maintaining independence when tasked with both monetary and fiscal objectives, Tracy said.   

"If Congress aligned the Fed's mandate with that of other major central banks, which is to focus solely on price stability, then there's no way with the Fed missing its inflation target for five years that they could move to accommodative monetary policy," he said. 

"Unfortunately, when you ask the central bank to choose between its two mandates in a supply shock, there’s pressure on the administration to encourage the Fed to choose the employment side," he said. 

"Maybe the data are signaling a future slowdown, but right now there's really not slack in the labor market. So it's interesting that the Fed is focusing on a potential problem rather than an actual, persistent problem."  

EASY POLICY

Policy is no longer restrictive after the December cut, based on estimates of r-star and financial conditions, Tracy said. The real neutral rate has risen to 1% to 2% on expectations of strong productivity growth. Assuming the natural rate of unemployment is 4.5%, Taylor rules suggest policy rates should be roughly a full point higher, he said.   

The Chicago Fed’s National Financial Conditions Index has also indicated looser-than-average conditions and is trending looser since late 2022.  

"They were on the low end of where they should have been before the cuts. Now they’re in accommodative territory," Tracy said.

With another round of stimulus from tax cuts hitting next year, ongoing tariffs and firms delaying price hikes on policy uncertainty, "we could very much be in a situation where inflation gets back to the low 3s over the course of the year," he said. "I don’t think it’s all behind us." (See: MNI: Fed Biased To Ease With Focus On Jobs - Ex-Officials)

INFLATION TAKES PRIORITY

The FOMC's latest projections have inflation hitting target in 2028. That long timeline puts the Fed's credibility at risk and makes it more challenging to return inflation to target, Tracy said. 

"Inflation expectations aren’t moving up now, but at some point people will say the Fed is not serious about 2%, otherwise they’d be acting on it. When they come to that view, expectations will rise."  

As the central bank faces down fresh tests of its independence in 2026, Congress should legislate to allow the Fed to focus solely on its inflation mandate, as dealing with inflation first and foremost is better for the labor market in the long run, Tracy argued.

"If we look back at the major times when the Fed has been pressured by the administration, it’s reasonable to assume that would not have happened at all or to a lesser degree if the Fed were only responsible for inflation," he said. 

"It would create cleaner lines of accountability and keeps the Fed out of anything that looks like fiscal policy."