Wednesday, February 3, 2016

San Francisco Fed President Says the Pace of Interest Rate Increases by the Fed Will Likely Be "A Smidgen" Slower Than He Thought in December

By Robert Wenzel

SF Federal Reserve President John Williams and's Robert Wenzel 
As I reported over the weekend, San Francisco Federal Reserve President John Williams spoke on Friday at a Commonwealth Club of California event in San Francisco at the Nikko Hotel.

I have already posted video of Williams attempting to justify an inflation target the Fed has set (SEE:VIDEO San Francisco Fed President Explains Why the Fed Has a 2% Price Inflation Target) and also a clip of Williams blaming foreign investors for part of the climb in real estate prices (SEE: San Francisco Fed Prez Blames Foreign Investors: "One of the Reasons US Real Estate Prices Are Going Through the Roof"), but there was more.

It is important to understand that prior to assuming the presidency of the San Francisco Fed, Williams worked directly for current Fed chair Janet Yellen for 6 years, when she was president of the SF Fed. They are close. If you follow his policy statements, as I do, it is clear to see he doesn't veer much from Yellen's view. That's why I tend to follow his comments closely. Not becasue he is a leader in setting policy direction the way the troika of Yellen, Fed vice-chairman Stanley Fischer and New York Fed President William Dudley are, but because he provides strong clues into Yellen's thinking.

One point he drives home regularly is that the Fed is "data driven." I believe it is an accurate description of how the Fed currently sets policy. The Fed sees it's job  as being something similar to driving a car. If the economy is slowing, they step on the money printing accelerator pedal. If the economy is racing. they step on the money printing brake.

This kind of Fed policy thinking is something the Fed can get away with when price inflation is low, as it is now. But when price inflation accelerates, they will never jam on the money printing brakes enough to slow the inflation. That takes a rare Fed chairman. Paul Volcker did it to a large degree, for a period, when he was chairman. I don't see that in the current Fed policy makers. In fact, I don't think they see the price inflation threat that is looming.

In the below clip from the press availability after his Commonwealth Club appearnce, Williams pointed out that he expects a bit slower GDP ahead then he had anticipated in December, "a smidgen" higher unemployment and a "a smidgen" slower process in interest rate "normalization." But what really caught my attention was his comment on price inflation. He expects that to be lower than he expected in December.

For sure, price inflation as measured by government indexes will be lower for awhile because of lower oil prices (which aren't part of the core inflation index Williams mentioned) but at some point, given the amount of money the Fed has pumped into the economy since 2008, the threat of a huge explosion in price inflation is very real. Williams doesn't seem to be aware of this threat at all.

In the next clip, below, Williams discusses the "tools" the Fed has to manipulate the money supply. He makes clear that he sees no immediate reason for the Fed to launch another round of QE or reverse the recent interest rate hike the Fed implemented.

But note well, when he talks about shocks to the system. he is focused on a down trending economy. The possibility of a rapidly accelerating price inflation doesn't  appear to be in the forefront of his mind.

When the accelerating price inflation comes, it is going to catch the Fed flat-footed and they are going to be way behind the curve in "battling" the inflation. I expect a first jump to the 3% range that the Fed will ignore as "noise," inflation will then jump to 5% and the Fed will raise rates a smidgen bit faster to battle that inflation rate but it will be too little too late, which could possibly mean inflation eventually approaching double digit levels.

I hasten to add, I don't expect this inflation acceleration to occur overnight, especially when oil prices are still falling, but the start could very easily be as little as only 6 months down the road.

Robert Wenzel is Editor & Publisher at and at Target Liberty. He is also author of The Fed Flunks: My Speech at the New York Federal Reserve Bank. Follow him on twitter:@wenzeleconomics

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