San Francisco Federal Reserve Bank President Mary Daly recently discussed the challenges of making policy projections due to increased uncertainty about the inflation outlook. Daly emphasized that inflation will be a “bumpy ride” and that there is uncertainty about the next few months of inflation. She outlined two possible scenarios for the path of interest rates, one with inflation resuming its decline and the other with inflation stalling out. Daly believes policy is still restrictive but cautions that it might take more time to bring down inflation.
Daly’s remarks underscore a careful and slow approach to setting interest rates, implying that current rates will likely remain for an extended period. The Fed’s interest rate-setting committee decided last week to keep its benchmark rate at a 23-year high, stating that more clarity is needed in the outlook for inflation before cutting rates.
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Inflation has shown a lack of progress in the first three months of the year, with officials reiterating the need for greater confidence in the inflation outlook before reducing rates. Other Fed officials, such as John Williams, Thomas Barkin, Neel Kashkari, and Susan Collins, have also expressed support for holding rates at current levels for longer.
One reason for the uncertainty is the correlation between inflation uncertainty and monetary policy uncertainty. As inflation uncertainty persists, especially around monetary policy turning points, the path for monetary policy becomes more uncertain. This correlation is evident in the increased financial and text-based measures of monetary policy uncertainty, which are well above their historical averages.
Inflation uncertainty has also been a global phenomenon in the post-COVID era. Economic uncertainty measures for 38 other countries, representing close to 90 percent of global GDP, have spiked around the global financial crisis and the COVID pandemic, remaining quite elevated since. Foreign inflation uncertainty has become the dominant source of economic uncertainty over the last two years.
In conclusion, Fed officials face significant challenges in making rate projections due to the high level of inflation uncertainty. This uncertainty is not limited to the United States but is a global phenomenon. The correlation between inflation uncertainty and monetary policy uncertainty further complicates the situation, making it difficult to predict the path of monetary policy.
