Richmond Fed President Lacker Talks of Pre-Emptive Rate Hikes

It is well-known that Richmond Federal Reserve president Jeffrey Lacker has been more of a hawk on interest rates than many of his Federal Reserve counterparts. Now he is back with fresh calls (or warnings) of rate hikes.

Lacker’s speech on Tuesday was at the West Virginia Economic Outlook Conference is Charleston, West Virginia. He sees a strong case for rising interest rates, even noting that a pre-emptive action likely would prevent the Fed from having to play a game of catch-up with more drastic actions ahead.

One message conveyed was that both sides of the Fed’s dual mandate (2% inflation cap and full employment) are performing quite well, even if inflation has been running below the Fed’s 2% target — because it has moved back toward that goal. His view is that history suggests that pre-emptive increases in the federal funds rate can help avoid situations that would require more drastic action after the fact.

Lacker also admits that GDP growth in this current recovery and expansion period has been low relative to historical trends. He also pointed out that we are starting to see evidence of rising real wages, with the last year’s wage growth outpacing inflation by about 1.5 percentage points.

Lacker’s speech shows that rates would be much higher in past instances of this economic picture. He said:

Now that employment and inflation are running at or very close to mandate-consistent rates, what does that imply for monetary policy? One way to address this question is to look at the Fed’s behavior during periods in which monetary policy is generally viewed as having been effective – for example, much of the period since the mid-1980s, particularly the period since the early 1990s. Where would interest rates have been set in the past for inflation and unemployment rates like we are seeing now? The answer is “much higher.” Even adjusting for the possible evolution of key parameters in those benchmark relationships, our policy rate should be 1 ½ percent or more by now. This is the basis for the strong case I have articulated for raising our interest rate above its current low level.

Lacker concluded with a rate hike reference:

The lesson I take from such episodes is that pre-emptive increases in the federal funds rate are likely to play a critical role in maintaining the stability of inflation and inflation expectations. While inflation pressures may seem a distant and theoretical concern right now, prudent pre-emptive action can help us avoid the hard-to-predict emergence of a situation that requires more drastic action after the fact. The current target range for the federal funds rate, at 25 to 50 basis points, is extremely low relative to the benchmarks I discussed earlier that capture historically successful policy. Careful attention to the lessons of history is likely to be crucial to preserving the important policy gains we have made.