Fed's Lacker Speaks- Makes case for rate increase
- 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.2 I will return to the subject of monetary policy later in my remarks.
- I'd like to close with some thoughts on the strategy of monetary policy. We did not drift into a low-inflation environment by accident. Instead, the Federal Reserve, under the leadership of Paul Volcker and Alan Greenspan, made the difficult decisions that were needed to push inflation down and keep it low. A pertinent example is the beginning of 1994. Core inflation for January 1994 was relatively low at 2.2 percent, year-over-year, and had drifted lower over the previous three years. Rather than wait to see inflation pick up, the FOMC began raising the target for the federal funds rate in February 1994 and increased the funds rate by 2 ½ percentage points over the next nine months. This pre-emptive action was successful and inflation continued to move lower. In November 1995 the two-year inflation rate moved below 2 percent for the first time in over 30 years, and it has averaged close to 2 percent ever since. And while some observers were fearful that the rate increases would derail the economic recovery, in fact the economy continued expanding until 2001. One could argue that the FOMC's pre-emptive moves in 1994 laid the foundation for the price stability we've enjoyed over the last 20-plus years.
- 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.
- Full Speech