Charles Evans, Speech: On Taming Inflation, Official Monetary and Financial Institutions Forum (OMFIF)

“Though the recent inflation data have been disappointing, most forecasters, myself included, anticipate that inflation in the U.S. will cool down substantially over the next couple of years.”

“First, even though some problems still remain, there are a number of signs that supply chain difficulties are improving: Ports are less congested, freight costs are falling, and supplier delivery times are improving. But all is not well yet.”

“Second, tighter monetary policy plays a very important role in my forecast of lower inflation. It is needed to pull back on aggregate demand and keep it from pushing too hard on today’s still-challenged supply conditions. It is also needed to prevent current large price increases from becoming embedded in pricing dynamics and longer-run inflation expectations.”

“Reducing inflation to a level consistent with the Fed’s 2 percent objective will require a period of restrictive financial conditions. These will generate below-trend growth and some softening of labor market conditions and restore better balance between supply and demand conditions in the U.S. My FOMC colleagues and I are acutely aware that this slowdown will, unfortunately, cause difficulties for some households and businesses. Yet, failing to restore price stability would result in far greater costs.”

Neutral Rate and Balance Sheet: “When making economic decisions, people naturally think about the future. With the median federal funds rate projected to be 4.4 percent by the end of the year and with core inflation next year forecast to be 3.1 percent, the real federal funds rate would be something like 1.3 percent. This is above the 1/4 to 1/2 percent range most FOMC participants see as the long-run real neutral rate, and so by this calculation, it’s clearly restrictive. And though the estimates are subject to a great deal of uncertainty, the reduction in our balance sheet is worth something like an additional 35 to 50 basis points of policy restraint.”

Forecasts:
“For GDP growth, the median projection for this year is only 0.2 percent, which is consistent with growth averaging only about 1-1/2 percent over the second half of the year. Growth is projected at 1.2 percent in 2023, below the 1-3/4 percent most see as the underlying trend. So monetary restraint is clearly showing through in these numbers. Real GDP growth is expected to return to trend in 2024 and 2025.”

“Under this GDP forecast, the unemployment rate is projected to rise to 4.4 percent by late 2023 and then remain near that level in 2024 and 2025. While this does represent a noticeably softer labor market when compared to today’s, we are not looking at recession-like numbers. Indeed, the peak projected unemployment rate is less than a half a percentage point above where the FOMC sees the unemployment rate settling at over the longer run.”

“As for inflation, with supply-side improvements, restrictive monetary policy, and below-trend growth, I expect inflation will moderate significantly. After all, that’s the goal. According to the median SEP projection, after ending this year at 5.4 percent, total PCE inflation is expected to fall to 2.8 percent in 2023 and 2.3 percent in 2024 before returning to our 2 percent target by the end of 2025.”