The second-in-command at the US central bank has said the Federal Reserve is “attentive to financial vulnerabilities” posed by the global campaign under way to tighten monetary policy and combat high inflation, but affirmed interest rates must keep rising until price pressures have abated.
Lael Brainard, the vice-chair, spoke at a volatile moment for global financial markets, which have whipsawed this week due to turmoil in the UK related to the government’s new fiscal plan and broader concerns about how aggressively the Fed will need to stamp out the worst inflation problem in four decades.
As central banks globally have raised interest rates and begun to shrink their record-setting balance sheets, that has resulted in a surge in borrowing costs and retreat from risky assets such as stocks.
“The global environment of high inflation and rising interest rates highlights the importance of paying attention to financial stability considerations for monetary policy,” Brainard said at a conference hosted jointly by the Federal Reserve and its New York branch on Friday.
“As monetary policy tightens globally to combat high inflation, it is important to consider how cross-border spillovers and spillbacks might interact with financial vulnerabilities.”
She said the Fed was “attentive” to those vulnerabilities, which “could be exacerbated by the advent of additional adverse shocks”.
Warning that the risk of additional inflationary shocks “cannot be ruled out”, Brainard emphasised the high level of engagement the US central bank has with its global peers and other financial authorities, including “frequent and transparent communication”.
She said the Fed met “regularly” with these counterparts in a bid to “take into account cross-border spillovers and financial vulnerabilities in our respective forecasts, risk scenarios and policy deliberation”.
One channel she highlighted is the impact of tighter US monetary policy on domestic demand for foreign products, which in turn has “amplifying” effects on monetary tightening from central banks abroad.
“The same is true in reverse: tightening in large jurisdictions abroad amplifies US tightening by damping foreign demand for US products.”
The IMF and other multilateral organisations have repeatedly warned about the acute risks confronting emerging and developing economies, many of which are saddled with large stocks of debt and whose servicing costs have ballooned as interest rates globally have risen.
Brainard spoke of this dynamic on Friday, cautioning that if concerns about debt sustainability mount, “deleveraging dynamics” could rise as market participants flee.
Despite these warnings, the vice-chair was unwavering in her view that monetary policy needs to tighten further in order to guard against future expectations of inflation getting out of hand and underscored the Fed’s commitment to “avoiding pulling back prematurely”.
In August, the Fed’s preferred inflation gauge — the core personal consumption expenditures price index — gained 0.6 per cent and is running at an annual pace of 4.9 per cent, data on Friday showed. The Fed targets 2 per cent inflation.
Brainard reiterated that “at some point” the Fed would need to consider if it was overdoing it. She acknowledged that the effects of the bank’s policy would take time to filter through the economy and that uncertainty about how far rates needed to rise was elevated.