MNI INTERVIEW: Fed Will Have Room To Cut Later This Year-Levy

The Federal Reserve should be able to lower interest rates in the second half of the year because the erosion of consumer spending and employment conditions resulting from the spike in energy costs will likely outweigh a temporary boost to prices, Mickey Levy, an outside advisor to several Fed Banks, told MNI.

The Fed is likely on hold for the next couple of meetings, he said in an interview. "And then I think the the transitory impact on inflation will work its way through," said Levy, a member of the Shadow Open Market Committee, a group of private academic economists that acts as the Fed’s outside watchdogs. At this point, he expects one or two rate cuts by the end of the year. 

The most likely scenario is the conflict in the Middle East lasts a couple more weeks and continues to pressure higher oil prices, before some sort of messy ceasefire. "With that scenario you would be touch and go with a mild recession and the Fed would be on hold between now and June but there would be room to cut rates after that," Levy said. 

RESIDUAL IMPACTS

"After the temporary zooming of oil prices works its way through the CPI temporarily on the monthly data over a two to three month period, then the Fed is stuck looking at the economy that is going to get hit by this," Levy said. "Growth in consumption was already slowing in response to the slowdown in the growth of real disposable income, and now that's going to be accentuated."

"Then beginning in June, the monthly inflation readings will come back down, and as they come down, the Fed will be looking at that transitory impact, but they'll be looking at the residual negative impact on the real economy and labor markets," he said. "Enter Kevin Warsh and there will be room for them to lower rates." (See: MNI INTERVIEW: Prolonged Fed Hold On Stagflation Risk-Lavorgna) 

A more negative scenario, however, would be that the bombing and the disruption to global oil continues for another month or two. "Then the impact on inflation lasts longer and the impact on the real economy in labor markets becomes more negative for longer." 

Levy, a visiting fellow at the Hoover Institution, said interest rate increases are unlikely, but the central bank should nonetheless keep its communications open to the possibility given that it hasn't reached it's 2% inflation target in 5 years.

Beyond the near-term outlook, Levy noted advancements in AI and a boost in the trend of productivity growth. "I find it very interesting that the Fed basically is on board with the productivity growth," Levy said. The Fed's latest median SEP estimates showed increases in the U.S. economy's long-run GDP growth rate to 2.0% from 1.8%, while the estimate of the neutral interest rate rose to 3.1% from 3.0%. 

COMPROMISE