Federal Reserve Bank of San Francisco President Mary Daly said policymakers will likely need to raise interest rates higher and maintain them at elevated levels for a longer period of time.
“It’s clear there is more work to do,” Daly said Saturday in remarks prepared for a speech at Princeton University in New Jersey. “In order to put this episode of high inflation behind us, further policy tightening, maintained for a longer time, will likely be necessary.”
Daly said inflation remains high in each sector — goods, housing and other services — and that the bumpy nature of incoming data paints an unclear picture for disinflation momentum. While Daly doesn’t vote on policy this year, she is a participant in Federal Open Market Committee meetings and discussions.
The Fed has tightened aggressively in the last 12 months, lifting its benchmark policy rate from nearly zero to a target range of 4.5% to 4.75%, though policymakers have recently slowed the pace of rate increases. They downshifted to a quarter percentage point move on Feb. 1 after hiking by a half point in December, which followed four consecutive 75-basis-point increases.
“This tightening, while pronounced, was and remains appropriate given the magnitude and persistence of elevated inflation readings,” Daly said.
Daly has said in the past that interest rates will likely need to rise to above 5% to be able to sufficiently cool demand and bring down inflation. She said last month that the FOMC’s December projections — which show rates peaking at 5.1% this year, according to the median forecast — were still a good signal of where policy was likely headed.
Inflation, which reached a 40-year high last year, fell in the last three months of 2022, but ticked back up in January. That month’s data also showed strong consumer demand and blockbuster hiring by firms.
Several of Daly’s colleagues have since said that interest rates may need to go higher than they previously thought, and investors are now betting on a peak around 5.45%. That level could be achieved by 25-basis-point hikes at each of the three following meetings. Daly did not specify in Saturday’s speech how much more tightening she thinks is appropriate.
Policymakers will update their economic projections at their March 21-22 meeting.
Daly also spoke about the uncertainty of what will most drive future inflation. Before the pandemic, Fed officials struggled for years to get prices up to the central bank’s 2% target as an aging workforce and sluggish productivity growth weighed on inflation.
Now, new factors including the reshoring of production, a domestic labor shortage, the need for increased investment in technology and infrastructure amid a transition to greener sources of energy, and a potential change to inflation expectations could all pressure inflation upward. How these forces interact with the disinflationary ones of the past remains to be seen, Daly said.
“We don’t know what the trend will be,” Daly said. “But we do know that, while we continue to diffuse the ongoing inflation shock, we need to be working to gather data and research that illuminates the likely path forward.”