When Loretta Mester speaks out on inflation, you better listen.
First, she spent nearly four decades in key positions at the Federal Reserve, starting at the Philiadelpha Fed in 1985 as an economist and moving up be director research, a top position where she was directly involved in key policy issues. In 2014 she went to become the the president of the Cleveland Fed and spent that tumultuous decade dealing first with the issue of inflation that stayed too far below target for too long and then later with the roller coaster inflation ride of the pandemic years when the consumer price index hit 9%.
Also worth noting, Loretta in 2018 built on the bank’s long history of research and analysis related to inflation measurement and forecasting to the launch of the Center for Inflation Research. Inflation is a subject she not only knows very well but also has dealt with as a policy maker at critical points in Fed policy making.
So as the Fed cuts its key rate for the second time year, and is putting the risk of a weakening labor market ahead of the risk of persistently high inflation - and a further rise in inflation expectations - what does she think of how the Fed is dealing with its dual mandate?
”When it comes to the labor market, monetary policy is not the tool to try to solve that problem. So again, they have to be wary about trying to push on that.,” she says. “Given that monetary policy doesn’t do much to affect the supply of the labor market.”
”Trying to use it for that is going to distract from the fact that you do need to run a somewhat restrictive monetary policy if you want to get inflation back to 2%.”
Loretta surprised me when I asked her if the Fed risks losing credibility on inflation if it allows it to stay above target for so long? Not because she said that it has not, but because she said it that it HAS so adamantly, pointing to recent polls that show just that.
”The Fed has lost credibility,” she says. “I mean, if you look at polls, right, Gallup runs polls, you know, the credibility of the Fed did go down, and that’s what you typically see when you have a big inflation problem.”
In fact, Loretta points the Cleveland Fed’s survey of business firm’s inflation expectations. Once a year, they ask, where do you think the Fed’s target is for inflation? That went up this year. Right? It went up to 2.5%, around 2.5%. So again, right, I think there…should be concern on the part of the Fed that it’s not just medium and long run.”
”My final point on that is…medium and long-run inflation expectations were pretty stable during the post-pandemic period. That did not prevent inflation from reaching levels of 7-9%, depending on how you measure it,” she adds.
So dive in and hear what Loretta hear more about why the Fed must take what looks like a growing risk seriously that needs more restrictive policy. And her view of another important policy step taken at the recent meeting, why the Fed is sending its QT - quantitative tightening - program and what it means for bond market functioning now and in the future.
The policy conundrum unfolds 00:01:32.250
I think <Jay Powell> clearly indicated that he’s keeping an open mind about the next meeting, because, I mean, he should, given, as you say, you know, the downside risks are to the employment part of the mandate, but there are upside risks to the inflation part of the mandate, so in that situation, I think he’s right to be wary of overcutting. You know, he may, you know, he might want to support the labor market, right? But he has to be very careful, because he needs to have a restrictive monetary policy. at least somewhat restrictive if he hopes to get inflation back down to 2%. And so I think he’s right to say, look, markets, and I think he was talking to the markets with that. We’re going to have to see how the economy evolves, and we’re going to be doing that work over the next intermeeting period, and then when we go into December, we may or may not Cut again, depending on where the economy is, and importantly, where they think it’s headed.
An uneasy balance in the labor market 00:03:27.450
Well, in my view, even going into yes, you know, the meeting this week, right, it wasn’t a strong case to cut. They followed through because that was widely expected, and they hadn’t pushed back on that view. So I don’t think it was a strong case, and for some of the reasons you pointed out, right, it isn’t clear that…the weakness in the employment part of the mandate is because of demand, right? We know that firms are wary to hire. They don’t want to over-hire workers because they don’t really know what’s coming next, and how much you know, the tariffs will flow through, and they want to protect their margins. On the other hand, there haven’t been, at least to this point, very many layoffs. So, I call it an un… I know the chair had called it a curious balance in the labor market. I call it an uneasy balance.
If I had a hammer…would it be the right tool? 00:04:16.450
You’d rather have a labor market that’s more vibrant than that. You’d want a labor market where people feel like if they decide that it’s not a good job that they’re in, they can quit and then get another job. But I think people are very wary of doing that, so we’re in this sort of stasis in the labor market. Not necessarily going to turn So we have higher unemployment, necessarily, or higher rates of unemployment, but still a sort of softening in the labor market. Unfortunately, if it’s mainly supply, monetary policy is not the tool to try to solve that problem. So again, they have to be wary about trying to push on that. Given that monetary policy doesn’t do much to affect the supply of the labor market. On the other hand, they do have an inflation problem.
But inflation IS a problem and it may not be temporary 00:05:10.260
Inflation has been above the target for over four and a half years now. And as much as their narrative has been focused on how its tariff-related, it’s a two-part narrative. One, most of the inflation and the increases we’ve seen are tariff-related, and two, that’s going to be a one-time increases in the price level, and once the price level finds its new higher <level> inflation will start moving back down. I don’t think either of those are correct. I think that it’s not all tariffs, because if you look underneath the hood, right, you see services, core services excluding housing. are not necessarily moving down. In fact, the last couple readings, some of those readings have moved up. So that suggests it’s more than just tariffs. And two. they’ve put a lot of weight on the narrative that these would be one-off tariff increases in price level <impact>, and what we found… and that logic is maybe that’ll be what happens, right? I’m not saying that’s not going to happen.
Is the tariff argument anything more than transitory revisited? 00:06:12.620
We’ve had that same kind of logic used during the post-pandemic period when inflation did surge. And we… I was on the committee at the time, there was just too much weight put on that scenario that this is going to be transitory inflation. And not enough on the other possibility, which was, this is going to be longer lasting, perhaps because, right, the supply chain constraints are not going to come off. as quickly as you might think, and therefore, the Fed would need to use monetary policy to bring demand to meet supply. Supply’s not moving back up to demand, it’s demand has to move down to supply.
Is the Fed beginning to see more of a case for tariff inflation risk 00:06:51.550
I think that, at least until what Chair Powell said at the press conference, I thought they had put way too much weight on that scenario, and not enough into entertaining other possibilities. Now, with the press conference, I think he was trying to be more…Even-handed there, and the fact that he did push back, and… and it wasn’t even pushing back to a question, it was in his prepared remarks. we’re not necessarily going to be cutting in December. He didn’t rule out another cut.
Policy now depends…but the data are missing…00:07:26.940
I think he was trying to say, look, it really depends on how things evolve, and it could be that their evaluation of the risk changes over time, precisely because of some of the things you pointed out, which is growth has been pretty resilient. You know, it is true that there are the lower-income people are feeling Right? More pain in the economy than the higher-income people, so they have been much more careful about their spending. But a lot of what they’re feeling is the inflation part, not necessarily the employment part.
How big is the FOMC Split? Listen to the coming speeches 00:09:21.640
Well, I think one way to get a really good indication of that is certainly listen to the speeches that we’ll start hearing in a couple days, but also, look at the last dot plot, right? The so-called dot plot from the summary of economic projections. There you see there’s quite a bit of a difference of opinion into what they believe appropriate policy is. And as all your listeners know, right, each participant on the FOMC, whether you’re a voting member or not, puts in one of those set of projections four times a year. And that showed, right, those were released in September, that showed that there was quite a difference of opinion among the participants on FOMC about where they thought it was appropriate to put policy. Now, of course, that isn’t a commitment, and as economic conditions change, right, they’ll be revising their views on that, but it does show. And I would submit that. It would be surprising, given the environment we’re in, and the economic environment we’re in not to see those type of differences. I’d be, frankly, more concerned if there weren’t differences in opinion. That would indicate that they’re really not having the kind of robust debate that you’d want them to have..
Dissent & differences of opinion are a good sign 00:10:51.910
Given there are these cross-currents and different views, and different, you know, risk preferences or risk weighting the two parts of the mandate. So that fact that there are different views is not a bad thing. It actually shows a healthy level of discussion that you’d want to have a deliberative body like the Fed and FOMC partake in.
Worried about policy tilt; Fed MUST BE restrictive 00:11:32.660
I mean, I’d be very cautious, and I don’t like some of the narrative out there, and I’m not blaming the Fed for this, but a lot of the analysts are basically saying, the media are saying, like, well, the Fed’s only focused on the employment part of the mandate. No, the Fed has to focus on both parts of the mandate. And the fact that inflation Is sticky. Has been sticky. is, I think, an important part of what’s… where they need to focus…And I worry that, you know, trying to use it for that is going to distract from the fact that you do need to run a somewhat restrictive monetary policy if you want to get inflation back. to 2%.
There is a real inflation risk; do not ignore the fiscal side 00:12:32.630
I think that would be sort of where I would be. This is an inflation risk that you have to take very seriously. I’d sort of be in that camp, I think. The other thing they have to be thinking about, though, is, you know, the economy, starting next year, right? There’s a lot of people who are going to get bigger tax refunds than they’re expecting, given the fiscal package that was passed. You have that zero depreciation, so expedited depreciation for businesses, so there’s going to be some stimulus coming on board as well, and so they’re going to have to be cognizant of that. One of the things I would say on our… when I was on the committee that we didn’t fully appreciate at the time was how strong the fiscal stimulus was.
Other issues: credit developments 00:13:20.000
When you’re setting monetary policy, you have to take the whole environment into account, and that’s something that I think they will need to keep an eye on early next year, too. I do think that there’s a trend, right, to go from the typical banking system type of credit, right, to more private credit, and it’s not that that’s necessarily more risky than other types of lending, but it is more opaque. And I think that’s the issue. The issue is not necessarily that, in and of itself, it’s more inherently risky. But if you don’t have eyes on it. It’s difficult to see and to make sure that, for example, collateral isn’t being re-hypothecated to support
QE/QT the Fed’s new view 00:17:04.329
The way the Fed wants us to think about it, and I think it’s the right way to think about it, is this is the way it implements monetary policy. It’s not… I think, currently, what it’s doing with the balance sheet is not an indication of where they’re moving monetary policy. During the pandemic, of course, when interest rates were at zero, right, we ended up purchasing a lot of assets, adding them to the Fed’s balance sheet. First, we did it because financial markets were so disrupted. that we went in and sort of stabilized the financial markets by purchasing a lot of bonds, and so that was the first reason. But then, once interest rates hit zero, the idea was we need to be more accommodative. One way to do that is to buy long bonds, which puts pressure on the long end of the bond market. At this point, right, they don’t need to use the balance sheet as a form of monetary policy, and what they’ve been doing is trying to allow the balance sheet assets to run off in order to shrink the balance sheet. They got to the point at this meeting, they announced, that they think that process is now done. They will end that.
Fed credibility is slipping… 00:20:19.810
So, the Fed has lost credibility. I mean, if you look at polls, right, Gallup runs polls, you know, the credibility of the Fed did go down, and that’s what you typically see when you have a big inflation problem. So, crises. institutions, you know, reliability on them, right? Reputations go down. The Fed’s been building that back up by trying to bring inflation down. So that’s one thing. Two, you’re right, the Fed does try to tend to focus on medium to longer run expectations, and if you look at the market measures, they certainly have been relatively stable. But I would submit that they should be looking at more than just the medium and long run. Inflation expectations. Short-run inflation expectations have risen. And moreover, surveys suggest that people are now beginning to think. That the target is higher than 2%.
Public perception of the target for inflation is shifting HIGHER 00:21:13.990
So the Cleveland Fed runs its survey of business firm expectations, inflation expectations. Once a year, they ask, where do you think the Fed’s target is for inflation? That went up this year. Right? It went up to 2.5%, around 2.5%. So again, right, I think there should… is… should be concern on the part of the Fed that it’s not just medium and long run. My final point on that is. Yeah, medium and long-run inflation expectations were pretty stable during the post-pandemic period. That did not prevent inflation from reaching levels of 7-9%, depending on how you measure it. So again, it may be a necessary condition to bring inflation back down to 2%, but it’s certainly not sufficient. And I think they should be concerned about how people are reacting to the higher inflation. If they’re making decisions based on
Still…could see a rate cut in December 00:22:40.320
Well, I think it’s going to go back to both parts of the mandate. If they get information that suggests that the labor market is deteriorating. I think that would precipitate a rate cut. Especially because they probably won’t have a lot more information that’s saying prices or inflation rates are picking up, right? The inflation usually moves a little bit slower. So, I think that would be the key, but whether that makes them… they will have to also evaluate how much of that is supply. Right? Conditions and how much is demand. So I don’t think it’s going to be an easy call. But I do think that you could see a rate cut in December. I think the chair has gotten to the point where he’s had enough…enough, sort of, skepticism about, you know, maybe things going on the labor market. Given the strength in the economy, give him a little pause about maybe things are deteriorating, but we’ll have to see. It really is going to depend on how the economy evolves.
Powell sent a strong message 00:25:03.300
He sent a strong message that he didn’t want everyone to just think that December was a done deal. But other than that, I think he’s going to be open-minded, and he’s going to look at the data, as the Fed always does, and use that to guide the decision. So again, I don’t think he probably knows today where he’s going to be in December. I think he’s going to be like the rest of the policymakers in saying, I’m going to look at what’s going on in the economy. They don’t have to decide today. What they need to do is communicate as clearly as they can.
So… who’s next?? 00:27:02.660
I don’t have any inside information on who the next Fed Chair is. It’s certainly not Jay Powell’s decision, about who the chair is. And I can assure you that none of this is influencing the decisions that the FOMC is making about monetary policy. When they enter that room. All of these kind of issues are left aside, and they really are doing the best job they can, using the best judgment, data, analysis, modeling to really try to set monetary policy to hit the dual mandate goals. So, as much as people outside, you know, want to sort of debate who the next chair is, that doesn’t enter that room. I’m hoping they get somebody who is going to be, as constructive as Jay Powell was in terms of getting the committee. On a path of really setting monetary policy on behalf of the public, and those dual… hitting those dual mandate goals, and someone who will not allow other issues to influence policy.
© Federal Reserve Bank of Philadelphia
Loretta Mester
Loretta J. Mester served as president and chief executive officer of the Federal Reserve Bank of Cleveland from June 2014 to June 2024. In that role, she participated in the formulation of US monetary policy and oversees more than 1,000 employees based at the Bank’s Cleveland office and Branch offices in Cincinnati and Pittsburgh who conduct economic research, supervise banking institutions, promote community development, and provide payment services to depository institutions and the U.S. Treasury. Mester represents the Fourth District on the Federal Open Market Committee (FOMC).
Mester began her career at the Federal Reserve Bank of Philadelphia in 1985 as an economist and was executive vice president and director of research at the Federal Reserve Bank of Philadelphia prior to her appointment as president and CEO of the Cleveland Fed on June 1, 2014.
Mester is an adjunct professor of finance at the Wharton School of the University of Pennsylvania. She has also taught in the undergraduate finance and M.B.A. programs at Wharton and in the Ph.D. program in finance at New York University.
Mester is a director of the Greater Cleveland Partnership, a trustee of the Cleveland Clinic, a trustee of the Musical Arts Association (Cleveland Orchestra), a director of the Council for Economic Education, a founding director of the Financial Intermediation Research Society, a member of the senior council of the Central Bank Research Association (CEBRA), and a member of the advisory board of the Financial Intermediation Network of European Studies (FINEST). She is a member of the American Economic Association, the American Finance Association, the Econometric Society, and the Financial Management Association International.
Mester graduated summa cum laude with a bachelor of arts degree in mathematics and economics from Barnard College of Columbia University. She earned M.A. and Ph.D. degrees in economics from Princeton University, where she was a National Science Foundation Fellow.
