Former Federal Reserve Governor Randal Quarles said Tuesday that he thinks the Fed will move swiftly to raise its policy interest rate above the inflation rate because that is the only way to defeat inflation.
When the policy rate is above inflation, it is what is known as a positive real rate of interest.
Quarles only left his post at the Fed at the end of December.
Asked during a forum sponsored by OMFIF, a think tank focused on central banking, whether he thought the Fed would engineer positive real interest rates, Quarles replied: “The short answer is yes.”
“We will see positive real interest rates, I think we will see that sooner rather than later because I think that is what will be required to get on top of inflation,” Quarles said.
The existing Fed interest-rate policy committee “is quite committed” to getting inflation under control, he added.
The U.S. inflation rate as measured by the consumer price index reached 7% in December. So, at the moment, the Fed would have to raise the nominal federal funds rate above 7% to have a positive real funds rate.
Most economists expect inflation to moderate nearer to 4% by the summer, but that is still much higher than the current nominal fed funds rate which is effectively at zero.
The Fed’s dot-plot projection of likely futures interest rates released last month only has the central bank raising its policy rate to 2.1% by the end of 2024.
The market now expects to hike its policy rate by quarter percentage point in March and raise rates three more times this year.
Fed Chairman Jerome Powell will discuss the central bank’s plans at a press conference Wednesday at the end of their two-day policy meeting.
Economists think Powell will try to calm the market’s frazzled nerves but say his options are limited given the high inflation rates.
Quarles said he didn’t think the Fed would start by hiking rates by a half a percentage point.
“That would be a kind of shock” Quarles said. He said it would “probably be enough of a signal” of the Fed’s intention to end asset purchases in March and start raising rates later that month.
Quarles said the policy framework the Fed adopted in 2020 meant that the central bank would wait until it saw “the whites of the eyes” of inflation before raising rates. “We never said we’d let the army march over us,” he said.
“The army is on top of us. The Fed will act and it will be successful at containing inflation,” he said.
There are unintended consequences of Fed raising interest rates significantly, Quarles said. The cost of financing the federal government will increase dramatically, he said, and there is the potential for unintended consequences from a private economy that has grown used to very low interest rates for a long period of time.
U.S. stocks DJIA, -0.19% SPX, -1.22% were again weak on Tuesday as investors worry about the economic impact of tighter Fed policy. The yield on the 10-year Treasury note TMUBMUSD10Y, 1.777% has retreated to 1.754% on Tuesday after almost reaching 1.9% last week.