By Michael S. Derby
Aug 6 (Reuters) - Federal Reserve Bank of St. Louis President Alberto Musalem on Thursday added his voice to the chorus of central bankers who believed the central bank should have raised its interest rate target last week.
“The federal funds rate is our primary tool for making monetary policy, and I expressed a preference at the meeting to raise the federal funds rate by 25 basis points,” Musalem said in remarks in Brazil.
The primary reason for favoring a boost in short-term borrowing
costs was based on the probability inflation will remain too high relative to the 2% target over the coming year or so if monetary policy stays at its current level, the official said.
Musalem said he also favored an increase now because “earlier gradual incremental interest rate increases are preferable, less disruptive, less costly than potentially later, more abrupt interest rate changes.”
The Fed held its interest rate target range steady at between 3.5% and 3.75% on July 29 despite inflation standing well above 2%. Three officials voted in favor of a hike at the gathering believing it was needed to lower price pressures, while other Fed officials over recent days have said either that the Fed should have raised rates last week, should hike in the future or be ready to if inflation doesn’t ease.
Fed Chairman Kevin Warsh has given essentially no guidance on what he thinks the Fed should do and has not said much about his decision-making process, and has instead said financial markets need to figure out the monetary policy outlook by themselves.
Musalem noted in his remarks that he closely watches markets and takes signal from them, but that’s about as far as it goes.
“If you think that now is the time to change policy in whatever direction, you ought to change that policy, irrespective of what's priced into markets,” Musalem said, adding “There are times or moments when it's okay to surprise the market.”
Musalem also said financial conditions are very supportive of economic activity and asset prices are elevated.
He also warned that while the public expects inflation to return to 2%, “there is fertile ground for inflation expectations to potentially become unanchored” if the Fed doesn’t get price pressures under control.
Musalem also said in his appearance that the Fed should not keep interest rate policy easier than it would otherwise be to support strong productivity levels in the hopes that will deliver lower price pressures at a later date.
“It is crucial that monetary policy put a meaningful restraint on underlying inflation, rather than tolerating somewhat higher inflation today to pursue productivity growth tomorrow,” he said.
He warned that trying to do so risks Fed credibility and added, "A central bank seen to tolerate above-target inflation on the promise of a future productivity windfall can put that anchor at risk,” Musalem said.
Musalem also said that the economy has been “resilient” over recent months, while noting “the labor market has stabilized with solid payroll growth and an unemployment rate close to its longer-run value.”
(Reporting by Michael S. Derby in New York; Editing by Matthew Lewis and Aurora Ellis)
