MNI INTERVIEW: More Fed Cuts Risk Inflation Spike-Weinberg

The Federal Reserve risks adding fuel to an already high inflation rate if it continues cutting interest rates while the economy remains on a firm footing, former Richmond Fed research director John Weinberg told MNI. 

“The danger with the Fed cutting in the face of above-target inflation is that it might send the signal, whether correctly or not, that the Fed will tolerate above-target inflation for longer than people had previously thought,” Weinberg said in an interview. 

The Fed lowered borrowing costs for a second straight meeting this week, though Chair Jerome Powell made clear a December cut is not a done deal – precisely because of lingering inflation concerns. (See MNI POLICY: Lingering Inflation Unease Tempers Fed Easing Push)

Additional easing could lead investors to expect higher inflation over longer horizons, leading to an unmooring of what are for now still-anchored longer-term inflation expectations, Weinberg said. 

“Eventually that works its way into expectations even further out the curve, and that's going to feed back into price-setting behavior and wage-setting behavior.”

INFLATION MOMENTUM

Weinberg said that while the textbook effect of tariffs is a one-time increase in the price level, adding monetary accommodation to trade-related cost rises could create a snowball effect. 

“What might give that momentum? It’s other people, like me, seeing what the Fed is doing and thinking about, is the Fed easing in the face of this?  Well, okay, then that might make this last a little bit, and so my next pricing decision might bake in a little more inflation,” he said.

“If that’s the feedback loop that’s going on then you have to ask what is the impetus to further falling inflation.”

Predicting what the Fed might do over the course of next year is made harder by a looming change in its leadership as President Donald Trump prepares to name a replacement for Powell, whose term expires in May. 

Weinberg, who led the Richmond Fed's research department for 10 years, said it will be key to monitor possible market reaction to the possibility of increased capture of the central bank by political interests given the pressure the administration has put on the institution so far.

“That could be a dramatic change. Then the interesting thing will be, when does that lightbulb go off in the heads of financial markets and we see, for instance, higher inflation getting priced over a longer-horizon?”

JOBS AND GROWTH

Weinberg said recent declines in employment growth must be taken in the context of sharp changes to the immigration landscape that make it harder to see weaker payroll gains as an outright decline in the demand for labor. 

“If supply is falling relative demand, then the net effect is tighter markets,” he said. 

So far, it’s not clear that the labor market is weak enough to warrant the Fed prioritizing that side of the mandate over a core inflation rate that is still hovering around 3%, said Weinberg.

“I have not seen strong evidence of that,” he said, adding that the economic backdrop appears resilient.  “Consumer spending has remained reasonably strong. We’ve certainly got a boom in capital expenditures driven by data centers.”