There are “significant upside risks” to the widely-shared view that inflation will decline sharply next year, said Fed Governor Randal Quarles on Wednesday.
In a speech to the 2021 Milken Institute Global Conference, Quarles said he is beginning to focus more of his attention on whether inflation will drop back down towards the Fed’s 2% target than on the labor market, which he said was “rapidly improving.”
Quarles is the third Fed governor to make remarks in the past two weeks that lean in the direction of the need to tighten monetary policy.
The Fed’s favorite measure of inflation, the personal consumption expenditure index, rose at a 4.3% annual rate in August, more than double the 2% rate that the central bank has targeted.
Quarles noted that most forecasters and he and most of his colleagues on the Fed’s interest rate committee, expect inflation to begin its descent toward 2% over the next year.
The fundamental dilemma that the Fed faces is that demand, boosted by fiscal spending, has outstripped a temporarily disrupted supply, which is leading to higher inflation. But trying to curtail demand to bring down inflation “would be premature,” he said.
Still, risks of higher inflation lie in the fact that supply constraints have already lasted longer than forecasters anticipated and “there is evidence in the past couple of months that a broader range of prices are beginning to increase at moderate rates,” Quarles said.
“Transitory does not necessarily mean ‘short-lived’,” he said.
The Fed governor said he doesn’t think the Fed is behind the curve on inflation and that conditions for raising interest rates have not been met.
But questions of how high inflation is too high and how long the Fed will tolerate high inflation are now relevant, he said.
In the near term, Quarles said he will support a decision at the Fed’s meeting in two weeks to begin to slow down the Fed’s $120 billion per month in asset purchases and end the quantitative easing by the middle of next year.
Michael Feroli, chief U.S. economist at J.P Morgan Chase& Co, said a November taper announcement is “now mostly a formality.”
The yield on the 10-year Treasury note
has risen steadily from close to 1.3% level at the last FOMC meeting in late September and is now above 1.6%.
Earlier this month, Quarles’ term as Fed Vice Chair for banking supervision expired. The post has yet to be filled by the Biden Administration. Quarles’ term as a Fed governor doesn’t expire until 2032.