Neel Kashkari, president of the Minneapolis Federal Reserve, in an interview on February 17, 2016.
David Orrell | CNBC
The Federal Reserve erred by raising interest rates during the recovery, part of a policy implementation that misread key signals and threatened to send the economy into recession, Minneapolis Fed President Neel Kashkari said Thursday.
In an unusually harsh rebuke of central bank actions, Kashkari said the central bank shouldn’t have tightened monetary policy with inflation so low. Instead, he said, the policymaking Federal Open Market Committee should be signaling that it will allow inflation to run higher than the 2% target, a move that would send a clear signal that the Fed is serious about stimulating the economy.
The FOMC hiked rates nine times starting in December 2015 as part of an effort to normalize policy following the extreme accommodations made during and after the financial crisis and Great Recession. Those hikes came even as inflation stayed well below the Fed’s goal.
“In my view, these rate increases were not called for by our symmetric framework,” Kashkari said during a speech in Santa Barbara, California.
The remarks came as part of a review the Fed is doing of its framework and the approach it has taken to jolting the economy back to life.
They also jibe closely with sentiments from the White House. President Donald Trump has repeatedly criticized the rate hikes and has said the economy would be much stronger had the Fed backed off.
While acknowledging the aggressive measures the central bank took — bringing its target rate down to near-zero and implementing three rounds of asset purchases that took its balance sheet to $4.5 trillion — Kashkari said the Fed should have kept its foot on the pedal.
He based his position on a job market that is still growing even though wage gains are still tame, and inflation is averaging around 1.6%.
“With inflation somewhat too low and the job market still showing capacity after 10 years, the only reasonable conclusion I can draw is that monetary policy has been too tight in this recovery,” he said.
Kashkari said one of the main problems was that Fed officials didn’t see how low unemployment could go without generating inflation. The current unemployment rate is at 3.6%, the lowest reading in nearly 50 years.
“I believe that we misread the labor market, thinking we were at maximum employment when, in fact, millions of Americans still wanted to work, and fearing that if we hit maximum employment, inflation might suddenly accelerate, and we would then have to raise rates quickly to contain it,” he said.
“The headline unemployment rate has been giving a faulty signal,” he added.
Even with the low rate, another gauge that includes discouraged worker and those holding part-time positions for economic reasons remains at 7.3%, reflective of slack remaining in the job market.
Kashkari said the lesson from the tightening cycle is that the Fed probably will want to be even more aggressive with policy in the next downturn. Evidence of tightening too fast came in the fourth quarter of 2018, when markets feared the Fed would continue raising rates and reducing its balance sheet and sold off aggressively.
“Perhaps we’d have achieved maximum employment already if monetary policy had been more accommodative,’ he said, adding that “by raising rates more quickly than called for by our symmetric framework, we ran the risk of overtightening and causing a recession. Markets signaled this risk with the steep drop in bond yields and equity prices late last year. The FOMC’s quick adjustment to pause further rate hikes was appropriate and, thankfully, seems to have mitigated this risk for now.”
However, he said he fears what may happen next time if the Fed doesn’t do a better job of listening to economic and market signals.
“For our current framework to be effective and credible, we must walk the walk and actually allow inflation to climb modestly above 2 percent in order to demonstrate that we are serious about symmetry,” Kashkari said. “Make-up strategies such as price-level targets offer this attractive feature. But we must honestly ask ourselves: If we felt compelled to raise rates when inflation was below target in this recovery, would we really keep rates low when inflation is above target next time? Count me as skeptical.”