“My preference would be not to raise rates again until we actually hit 2 percent core PCE inflation on a 12-month basis, unless we have seen a large drop in the headline unemployment rate signaling that we have used up remaining labor market slack, or a surprise increase in inflation expectations,” Kashkari wrote on Medium.com.
In an effort to spur growth during the financial crisis, the FOMC took its benchmark funds rate to near-zero in late-2008, then kept it there for seven more years. Since then, the Fed has hiked the rate four times to the current range of 1 percent to 1.25 percent.
In addition to keeping rates low, the Fed initiated three rounds of bond buying that boosted its balance sheet to $4.5 trillion, a process that it will start unwinding in later this month.
According to the most recent projections, released in September, the committee figures there to be seven more hikes between now and the end of 2019, bringing the funds rate to about 2.8 percent.
Sending up that flare has tamped down inflation expectations as markets view the Fed preferring pre-emptive hikes rather than waiting for inflation to hits target, Kashkari argued.
“We know that monetary policy operates with a lag. I believe these actions to remove various forms of accommodation are now having an effect on the economy by lowering inflation expectations,” he said.
“In my view, inflation expectations declined because actual inflation was below target for a long time, and the Fed’s actions to reduce accommodation led to a weakening of confidence that it was serious about bringing inflation back to target in a reasonable time frame,” Kashkari added.
Fed Chair Janet Yellen and others at the central bank have argued that inflation is low due to transitory factors like declines in cell phone plan pricing. However, Kashkari said inflation has remained low globally due to central banks collectively following similar practices.
“The only explanation that would potentially call for further policy tightening is the transitory factor explanation. But the longer low inflation persists (here and around the world), the more tenuous that story becomes,” he said.
“Allowing inflation expectations to slip further will mean that we will have less powerful tools to respond to a future economic downturn. I believe these are significant costs that we must consider as we contemplate the future path of policy.”