Raphael Bostic, Essay: Risk Management Is Key to Monetary Policy in Uncertain Times

“In an environment fraught with unknowns, the last thing the Fed wants to do is add to the uncertainty. While clear analogies to our recent experience are scarce, history is instructive on this point. What economists have come to call stop-and-go monetary policy—tightening in the face of rising inflation but then reversing course abruptly when unemployment rises—arguably helped to fuel inflation during the late 1960s and 1970s. Partly as a result, elevated inflation took root and policymakers ripped it out of the economy only after a pair of recessions in the early 1980s.”

“As the Committee confronts this immense challenge, I think two key questions should frame the policy debate. One, given that we are at or near a neutral policy stance, where monetary policy neither stimulates nor restricts economic growth, what level of rates would be appropriately restrictive? Two, how long will it take monetary policy to affect GDP and inflation?”

“In pursuit of that stance, I think it is worth emphasizing that monetary policy does not produce immediate results. History and a convincing body of research tell us that our policy tools work with a lag. Monetary policy tightening tends to affect other economic indicators such as the housing market, which has already notably slowed, before it meaningfully influences underlying inflation. That broad impact makes it critical that we pay attention to how all parts of the economy are evolving and remain steadfast if, as is likely, inflation doesn’t fall right away.”

“Even though it will take time to see the full effect of the policy adjustments we have made to date, I don’t think we are done tightening. Inflation remains too high, and our policy stance will need to move into restrictive territory if inflation is to come down expeditiously. That said, incoming data—if they clearly show that inflation has begun slowing—might give us reason to dial back from the hikes of 75 basis points that the Committee implemented in recent meetings. We will have to see how those data come in.”