One of the leading economists in the United States says the world’s largest economy is still in the grip of an inflationary crisis that is likely to persist for the foreseeable future.
Key points:
- The US consumer price index reached 8.5% in July
- Loretta Mester believes the Fed rate will likely hit 4% next year
- If US inflation and interest rates remain high, it will likely affect Australia
Loretta Mester is the president of the Federal Reserve Bank of Cleveland, which means she is currently one of 12 people who determine the official interest rate in America.
In an exclusive interview with ABC, Ms. Mester issued a warning to Americans struggling under the pressure of sharp price increases.
“I don’t have enough evidence right now to even conclude that inflation has peaked in the United States,” he said.
This puts it at odds with US President Joe Biden’s claims that inflation “could, could be – I’m not exaggerating – could start to decline.”
Mr. Biden has come under tremendous political pressure to curb price increases, which have reached their highest levels for many decades this year.
His government welcomed the news that the US consumer price index (CPI) hit 8.5% in July, which, while still high, was down from its 40-year high on the 9th. 1% in June.
But some economists have been cautious about the data, especially given recent examples of slowing inflation and then accelerating in the following months.
Another positive point in recent months has been the decline in gasoline prices in the United States.
But Ms. Mester said this happened during the height of the Northern Hemisphere summer and she doesn’t believe the trend will continue to the downside.
“There is good reason to think that with the winter, those prices could rise,” he said.
As temperatures drop in the global north, countries will desperately vie for sources of gas and oil to heat homes and power companies.
Such sources will be severely limited in the West due to sanctions on Russia in response to President Vladimir Putin’s war in Ukraine.
“The Fed will have to do much more”
Ms. Mester is one of the most knowledgeable people about the country’s economic status and one of the most powerful in defining its economic direction.
He is a member of the Federal Open Market Committee (FOMC) and meets with his fellow members eight times a year.
They review economic and financial conditions and assess the risks to its long-term goals of price stability and sustainable economic growth.
So far this year they have raised interest rates at a mouth-watering rate, from the actual zero in March to more than 2.25% today.
The Federal Reserve’s most urgent goal right now is to tame inflation.
With CPI currently at 8.5%, more work will need to be done to bring it back to the 2% target set by the Federal Reserve.
“I’m still very worried about inflation, it’s at unacceptably high levels,” said Ms. Mester.
“And I think the Fed will have to do a lot more to get that inflation data on that downward path.”
This would likely mean an increase in even higher interest rates for borrowers in the United States.
“My reading right now is that we will probably have to raise the Fed funds nominal rate a little above 4% early next year, and then keep it there for the whole year,” he said.
By raising interest rates, the Federal Reserve is attempting to raise the cost of borrowing by making people spend less.
The hope is that this will take some demand out of the economy to bring it into balance with supply at a lower price.
It is already having an impact in bringing down stock markets and house prices.
What about the possibility of a recession?
Ms. Mester knows that any hike comes with risks, as the FOMC tries to find the right balance between getting some momentum out of the economy but not too much that it crashes or goes over the proverbial limit.
“We hope to do it in a way that the economy doesn’t go into a deep recession,” he said.
“But it will be somewhat painful and it will feel painful.”
Recessions, which are usually defined as a significant decline in widespread economic activity in the market lasting more than a few months, are characterized by layoffs and falls in asset prices.
But even as interest rate hikes hurt borrowers and recessions lead to job losses, Ms. Mester said the path of higher interest rates is one the country has to endure.
“If we didn’t, it would be worse,” he said.
“If you are a low-income family, you have to make choices that are extraordinary choices.”
He said he knew some Americans made fewer trips to the supermarket or bought cheaper products to save money at the checkout.
“The longer it goes on, the harder it will get. So there is already a lot of pain from this high inflation,” he said.
“And I think it’s something to remember: it’s not about the future. It’s like right now, there’s a lot of pain here.”
What Mester’s warning means for Australia
The United States remains the most important economy in the world and its vitality is crucial to the health of middle powers like Australia.
As the US continues to raise interest rates, it is also putting pressure on smaller countries and giving room to raise their own rates.
This is because the Federal Reserve has tremendous influence and operates in an interconnected global financial system.
So an increase in the cost of borrowing in the US can affect both the rates at which Australian banks borrow and the value of the US dollar.
Meanwhile, runaway inflation has increasingly become a global problem, although the US has been dealing with it for longer than most.
The Australian CPI reached 6.1% in the June 2022 quarter.
As a result, the Reserve Bank of Australia again raised interest rates by 0.5 percentage points this week, bringing its exchange rate target to 2.35%.
If Ms. Mester’s predictions are correct, inflation will bother families and governments in the near future.
And that means interest rates will also stay higher for longer.
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