Fed Governor Christopher Waller: Could cut interest rates as early as July

Summary of Fed Governor Christopher Waller's Interview

Key Concepts:

• Tariff effects on inflation
• "Good news" rate cuts
• Long-run neutral policy rate
• One-off level effect vs. persistent inflation
• Second-round effects (wage-price spiral)
• Labor market softening
• Long and variable lags

1. Tariffs and Inflation:

• Main Point: Governor Waller believes the Fed should "look through" tariff effects on inflation, a view based on a long-standing principle in central banking.
• Supporting Evidence: He argues that tariff-related inflation is likely to be a "one-off level effect" rather than causing persistent inflation.
• Data: He notes that recent inflation data has been "pretty good," even on a 12-month basis, supporting the idea that underlying inflation trends are under control.
• Argument: Waller contends that waiting to see the impact of tariffs is unnecessary because the impact will be the same regardless of when they are implemented.

2. Interest Rate Cuts:

• Main Point: Waller advocates for starting to cut interest rates, potentially as early as July.
• Rationale:
  • Inflation is near target.
  • GDP growth is near the long-run target.
  • Unemployment is at the long-run target.
  • The current policy rate is 125-150 basis points above the median long-run neutral policy rate.
• Process: He suggests a gradual approach to rate cuts to avoid "big surprises."
• Contingency: He acknowledges the possibility of pausing rate cuts if there are significant shocks, such as from the Middle East conflict.
• Quote: "I labeled these good news rate cuts. When inflation comes down to target we can actually bring rates down."

3. Disagreement within the FOMC:

• Context: The interviewer points out that the Summary of Economic Projections (SEP) indicates that seven members of the committee do not want to cut rates at all.
• Waller's Response: He emphasizes that the Fed should be data-dependent and that the data supports starting to cut rates. He reiterates his view that tariff effects should be looked through.

4. Concerns about Persistent Inflation:

• Counterargument: The interviewer raises the concern that tariff-induced price increases could spill over into other prices and cause broader inflation.
• Waller's Rebuttal: He acknowledges this concern but argues that the labor market is not strong enough to cause a wage-price spiral (second-round effects).
• Explanation: He points out that employers are unlikely to grant large wage increases to compensate for tariffs, especially given the current labor market conditions.
• Example: He references a speech he gave in Korea where he explained why he doesn't expect persistence, focusing on the labor market dynamics.

5. Labor Market Concerns:

• Indicators: Waller expresses some concern about the labor market, citing:
  • Negative Philly Fed unemployment data.
  • Modest rise in jobless claims.
  • Downward revisions to employment levels.
  • A Wall Street Journal article highlighting a 20-25 year high in unemployment for new college graduates (7% vs. 5% pre-pandemic).
  • Decreasing job creation.
• Urgency: He argues that if there are concerns about the downside risk to the labor market, the Fed should not wait for a "crash" before cutting rates.
• Quote: "People love to talk about long and variable lags. Why do we want to wait until we actually see it crash before we start cutting rates?"

6. Technical Terms:

• Basis Points: One hundredth of a percentage point (e.g., 100 basis points = 1%).
• Long-Run Neutral Policy Rate: The interest rate that neither stimulates nor restrains economic growth in the long run.
• Summary of Economic Projections (SEP): A document released by the Federal Reserve that contains FOMC participants' projections for key economic variables, including GDP growth, unemployment, and inflation.
• Philly Fed: The Federal Reserve Bank of Philadelphia, which conducts surveys and releases economic data.

7. Logical Connections:

• Waller's argument for cutting rates is directly linked to his belief that tariff effects should be looked through. If tariffs are not expected to cause persistent inflation, then there is less reason to keep rates high.
• His concerns about the labor market provide an additional rationale for cutting rates, as a weakening labor market could further dampen inflation and potentially lead to a recession.

8. Synthesis/Conclusion:

Governor Waller advocates for a proactive approach to monetary policy, arguing that the Fed should begin cutting interest rates soon, potentially as early as July. He believes that the current economic data supports this move, as inflation is near target, GDP growth is solid, and the labor market, while still relatively strong, shows signs of softening. He dismisses concerns about tariff-induced inflation, arguing that it is likely to be a temporary phenomenon that should not derail the Fed's plans to normalize interest rates. He acknowledges the disagreement within the FOMC but emphasizes the importance of being data-dependent and acting before the labor market deteriorates significantly.