The U.S. central bank’s second-in-command said the Federal Reserve was ‘mindful of the financial vulnerabilities’ posed by the ongoing global campaign to tighten monetary policy and tackle high inflation, but assertive interest rates must continue to increase until price pressures have eased.
Lael Brainard, the deputy chair, spoke at a volatile time for global financial markets, which slumped this week due to unrest in the UK over the government’s new budget plan and wider concerns over the aggressiveness with which the Fed will have to eradicate the worst inflation problem in four decades.
As central banks around the world raised interest rates and began shrinking their record balance sheets, it led to soaring borrowing costs and a pullback from risky assets such as stocks.
“The global environment of high inflation and rising interest rates underscores the importance of paying attention to financial stability considerations for monetary policy,” Brainard said at a conference co-hosted 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 spillovers and cross-border spillovers might interact with financial vulnerabilities.”
She said the Fed was “watchful” for these vulnerabilities, which “could be exacerbated by the advent of additional negative shocks.”
Warning that the risk of additional inflationary shocks “cannot be ruled out,” Brainard highlighted the US central bank’s high level of engagement with global peers and other financial authorities, including “frequent and transparent communication.”
She said the Fed meets with these counterparts “regularly” with the goal of “taking cross-border spillovers and financial vulnerabilities into account in our respective forecasts, risk scenarios and policy deliberations.”
One channel she pointed to is the impact of US monetary policy tightening on domestic demand for foreign goods, which in turn has “amplifying” effects on central bank monetary tightening abroad.
“The same is true in reverse: tightening in major overseas jurisdictions amplifies US tightening by dampening foreign demand for US products.”
The IMF and other multilateral organizations have repeatedly warned of the acute risks facing emerging and developing economies, many of which are struggling with large stocks of debt and whose servicing costs have soared to as global interest rates have risen.
Brainard spoke about this dynamic on Friday, warning that if concerns about debt sustainability increase, “deleveraging momentum” could increase as market participants flee.
Despite these warnings, the vice president remained convinced that monetary policy still needs to tighten in order to hedge against future expectations of slipping inflation and underlined the Fed’s commitment to “avoid premature backsliding”.
In August, the Fed’s favorite gauge of inflation – the core personal consumption expenditure price index – gained 0.6% and is running at an annual rate of 4.9%, data showed on Friday. . The Fed is targeting 2% inflation.
Brainard reiterated that “at some point” the Fed should ask itself if it is doing too much. She acknowledged that the effects of the bank’s policy would take time to trickle down to the economy and that uncertainty about the magnitude of the rate hike was high.