The Fed Thought Inflation Would Be Transitory, But It Was A Mistake: Waller

Federal Reserve Governor Christopher Waller said Friday the Fed made a mistake in not restricting monetary policy earlier, owing to the the logic that the inflation of 2021 was transitory.

What Happened: “The [transitory] story held from April until September 2021,” Waller said during a Council on Foreign Relations event in New York.

“Inflation was coming down monthly, it looked transitory,” the central banker said. “Then, October, November, and December of 2021, [inflation] just exploded.”

Waller said the Fed “bet the farm” on the transitory story in 2021, and said the mistake was not studying a risk model that showed inflation staying higher for longer.

Fed Chair Jerome Powell retired the term “transitory” in December 2021 after consecutive months of price hikes, admitting that inflation then could no longer be categorized as short-term.

“2022 was a humbling experience,” Waller said, alluding to the string of unprecedented 75-basis-point rake hikes the Fed doled out in an attempt to control inflation last year.

Read also: Fed's Williams Believes Monetary Policy Has More Work To Do: 'Critical We Stay The Course Until Job Is Done'

Why It Matters: Looking forward, Waller said that while inflation is beginning to come down, it’s not time to declare victory, as he favors a 25-basis point rate hike at the next Fed meeting.

“I currently favor a 25-basis point increase at the FOMC’s next meeting at the end of this month,” Waller said. “Beyond that, we still have a considerable way to go toward our 2% inflation goal.”

Patrick Harker, president of the Philadelphia Federal Reserve, and other officials have indicated a 25-basis-point hike is ahead. 

While the market and the Fed seem to agree on the direction that interest rates will take in the near future, there is a separation of expectations on a longer time horizon.

Central bankers say they expect rates to remain high through the end of the year, while markets expect a peak in the summer and a decline shortly after.

Waller said the separation in expectation is about the perception of where inflation is going to go.

“The market has a a very optimistic view that inflation is just going to melt away,” he told Steve Liesman. “We have a different view. Inflation’s not just going to miraculously melt away. It’s going to be a slower, harder slog to get inflation down and therefore we have to keep rates higher for longer and not start cutting rates by the end of the year.”

Watch the interview here:

Photo via Shutterstock.