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Richmond Fed President pushes for interest rate hike

Richmond Federal Reserve Bank president Jeffrey Lacker said in a speech Friday that the nation’s current economic outlook indicates interest rates are “likely to continue to rise,” and that there is a “strong case for raising interest rates sooner rather than later.”

The speech, delivered before the Virginia Association of Economists and the Richmond Association for Business Economics, put Lacker squarely in the camp that believes the Fed must move on rates to stave off the return of the kind of inflationary pressures that plagued the U.S. economy in the 1970s.

The Fed last raised interest rates in December 2015, establishing a target range of rates at or between 0.25 percent and 0.50 percent. Interest rates had been set at or near zero between 2008 and 2015.  

Lacker said the Fed’s own indicators of inflation and economic growth show current interest rates “should be significantly higher” than they are now.

He said the Fed’s reluctance to raise rates, which he believes should have been increased in July, hurts the central bank’s credibility.

“The historical record suggests that uncertainty about future [Federal Reserve] policy can destabilize inflation expectations,” Lacker said. 

“As inflationary pressures built in the late 1960s and the Fed did not fully respond, the public’s expectations about future policy became unanchored,” he said, “giving rise to a spiral of inflationary instability that was costly to tame.” 

Lacker said some economists believe that sort of economic uncertainty is no longer present, as neither labor unions nor commodity supply shocks, such as the 1973 oil embargo, have the same influence on the U.S. economy.

Despite these differences, Lacker said, “there are disturbing similarities between then and now” that could cause people to lose faith in the Fed's handling of the economy.

Professor Steve Horwitz, a visiting scholar at the Schnatter Institute for Entrepreneurship and Free Enterprise at Ball State University, told AMI Newswire that Lacker’s speech “explains the thinking at the Fed.”

But Horwitz disagreed with the focus on Federal Reserve interest rate policy.

“Interest rates aren't the issue,” Horwitz said, "at least in the sense of the ‘thing’ that causes or dampens growth.

"Paying attention to the expansion or contraction of the money supply itself is more important,” Horwitz said, "as are factors on the demand side of the lending market.

"Why are firms so reluctant to demand funds for investment, which is one factor leaving rates so low? What's going on in the real economy — regulation, uncertainty, etc. — that has firms so reluctant to demand loanable funds?” Horwitz said.

“I would like to see higher rates, not from the Fed,” Horwitz said, "but from more people wanting to borrow and from ending interest on reserves so that banks have more incentive to lend, rather than sit on their reserves.”

Lacker said the remedy for “unraveling inflation expectations” is to raise rates rapidly, as occurred in the late 1970s and early 1980s under the leadership of then-Federal Reserve Chair Paul Volcker.

He added that such a response makes it hard to avoid “precipitating a contraction” in the economy. 

“While inflation risks might not be fashionable,” Lacker said, “I think we should pay close attention when our policy benchmarks move far away from our current policy rate."

In a speech on Aug. 26, Federal Reserve Chair Janet Yellen said the Federal Open Market Committee, the voting body that sets interest rates, "continues to anticipate that gradual increases in the federal funds rate will be appropriate over time to achieve and sustain employment and inflation near our statutory objectives.

"I believe the case for an increase in the federal funds rate has strengthened in recent months," Yellen said.

"Of course, our decisions always depend on the degree to which incoming data continues to confirm the Committee's outlook."

The Federal Open Market Committee holds its next meeting on Sept. 20 and 21.