Federal Reserve’s Kashkari Predicts 40% Probability of Significant Rise in Interest Rates

Minneapolis Federal Reserve President Neel Kashkari believes that there is a nearly 50-50 chance that interest rates will need to be significantly increased in order to reduce inflation.

In a recently published essay on the Federal Reserve Bank of Minneapolis’ website, Kashkari states that there is a strong argument to be made that the U.S. economy is heading towards a “high-pressure equilibrium.” This scenario would involve sustained growth with robust consumer spending and a strong economic foundation.

If this situation arises, the inflation rate would decline but remain above the Federal Reserve’s target of 2%, creating a challenge for policymakers.

“The case supporting this scenario is that most of the disinflation we have witnessed so far can be attributed to factors on the supply side, such as workers reentering the labor force and supply chains resolving, rather than monetary policy restraining demand,” Kashkari explains in his essay titled “Policy Has Tightened a Lot. Is It Enough?”

Kashkari highlights the resilience of interest rate-sensitive sectors such as housing and autos, despite the Federal Reserve’s tightening measures. This raises the question of whether the current monetary policy is truly tight. If it were, would such robust economic activity be observed?

Although services inflation, excluding the cost of renting shelter, has been decreasing, it remains elevated, creating concerns for the long term.

“Once supply factors have fully recovered, is the current monetary policy sufficient to bring services inflation back to the target? It might not be, in which case we would have to raise the federal funds rate higher, potentially significantly,” Kashkari states. “Currently, I estimate a 40 percent probability for this scenario.”

However, this still means that Kashkari assigns a 60% chance of the Federal Reserve achieving its “soft-landing” objective, where inflation returns to its target without causing a detrimental recession. The progress made so far against inflation and the performance of the labor market are factors contributing to this positive outlook.

These statements by Kashkari come on the same day that The Times of India published an interview with JPMorgan Chase CEO Jamie Dimon, who entertains the possibility of the Federal Reserve raising its benchmark rate to 7%. Currently, the targeted range for the fed funds rate is between 5.25% and 5.5%.

Several other Federal Reserve officials have also expressed expectations of keeping interest rates elevated for an extended period of time.

While Kashkari has previously been known for his more dovish views on interest rates and monetary policy, he has adopted a more hawkish stance in recent months due to concerns about the factors maintaining inflation above the target. This year, Kashkari serves as a voting member of the Federal Open Market Committee, which recently decided to maintain interest rates while signaling a potential quarter-point hike before year-end.

Recognizing the progress that has been made, as well as market and consumer expectations of declining inflation, Kashkari suggests that the neutral rate of interest may have increased in the current economic era, necessitating a tighter policy.