High Interest Rates Still Needed to Lower Inflation, Fed official Hints

According to Fed official Mary Daly, higher interest rates are still required to reduce inflation and demand in the US economy. Though it’s unclear which scenario is more plausible, Daly thinks the Fed is prepared to act in response to both a deteriorating labour market and inflation staying above its target. Since 2018, Daly has served as the head of the San Francisco Fed and is a voting member of the Federal Open Market Committee.

The personal consumption expenditures price index, the Fed’s chosen gauge of annual inflation, dropped from a peak of over 7% in 2022 to less than 3% in the fourth quarter of the previous year. The PCE price index increased 2.7% year over year in April, but the index has since stagnated sideways. Daly credits supply-side factors, such as expanding labour forces and better supply networks, for the majority of the decline in inflation in the second half of 2023. She believes that this year’s rising interest rates will start to affect demand and curb inflation.

As demand has slowed, so has the labor market, but the rise in unemployment has been modest compared to the decline in inflation. There is likely to be less help from supply-side factors in the remainder of 2024, as supply chains have largely recovered from pandemic-era disruptions.

Further slowing in demand could mean more meaningful softening in the labor market, as job openings are down significantly and future belt-tightening by employers could come from actual jobs, not vacancies. The FOMC will need to keep an eye on both sides of its mandate—inflation and full employment—as they work to achieve their goals.