Federal Reserve Bank of Minneapolis President Neel Kashkari expressed concern that the Fed’s interest rate target might be too low to control inflation. In an essay published on the Minnesota Fed’s website, Kashkari argued that the strength of the labor market and housing market could be signaling the need for higher interest rates than Fed officials currently believe.
Despite the Fed’s significant policy tightening in recent years, Kashkari found it difficult to explain the continued robust economic activity. Fed Chair Jerome Powell and other central bankers have stated that current monetary policy is restrictive enough to combat inflation, with the Fed raising its benchmark interest rate target from zero to 0.25 percent to five to 5.25 percent between 2022 and 2023.
Kashkari suggested that certain parts of the economy, particularly housing, indicate that the neutral interest rate may be higher than what Fed officials estimate. This could mean that current interest rates are not as far above neutral as believed, and therefore not as restrictive.
The implication of this analysis is that interest rates may need to be raised further to achieve the Fed’s target inflation rate of two percent. Despite signs of some economic drag from high interest rates, overall economic activity has remained strong, with notable growth and low unemployment levels.
While financial conditions appear tight, with indicators like the inversion of the yield curve and rising delinquencies on loans, the resilience of the housing market poses a challenge to this view. Factors such as a housing shortage, increased migration, and remote work driving demand for housing could be supporting the market and influencing the neutral interest rate.
Kashkari revised his forecast for the longer-run neutral rate from two percent to 2.5 percent, suggesting that interest rates may need to be adjusted accordingly. However, it is worth noting that Kashkari is not a voting member of the Federal Open Market Committee (FOMC) this year.
