NY Fed president Bill Dudley says the Fed must continue to raise interest rates – here’s why that’s dangerous

William Dudley, president of the powerful Federal Reserve Bank of New York and a former Goldman Sachs partner, is pushing a dangerous economic idea.

He argued in a speech this week that the Fed is forced to continue raising interest rates lest the US unemployment rate “crash” to unsustainably low levels and boost inflation abruptly.

“If we were not to withdraw accommodation, the risk would be that the economy would crash to a very, very low unemployment rate, and generate inflation,” Dudley said. “Then the risk would be that we would have to slam on the brakes and the next stop would be a recession.”

Dudley, who spent many years as Goldman’s chief economist, should know better. The idea that the Fed should raise interest rates early in order to have more ammunition and be able to cut them later doesn’t make sense if the economy is not ready. It would amount to precipitating an economic slowdown in order to treat it.

The New York Fed president is especially influential because he has a permanent vote on the Federal Open Market Committee, unlike other regional presidents who rotate in alternate years, and he also automatically holds the position of FOMC vice chair.

Fed Chair Janet Yellen herself has acknowledged it would be easier for the Fed to deal with an inflation spike than another decline. “The federal funds rate is still near its effective lower bound. If inflation were to remain persistently low or the labor market were to weaken, the Committee would have only limited room to reduce the target range for the federal funds rate,” she told Congress in June of last year. “However, if the economy were to overheat and inflation seemed likely to move significantly or persistently above 2%, the FOMC could readily increase the target range for the federal funds rate.”

Given an inflation rate that has consistently undershot the Fed’s 2% target for most of the eight-year economic expansion, there’s a strong case to be made that central bank officials should be testing the lower bound of the jobless rate and reassessing how low it can go without actually becoming inflationary.

That’s what Minneapolis Fed President Neel Kashkari, who dissented against the June decision to raise interest rates to a 1% to 1.25% range, would prefer to do.

Even Yellen declared an openness to potentially raising the central bank’s 2% inflation target during her June press conference, a sharp break from her earlier views on the matter. This seems contrary to Dudley’s idea of an imminent and somehow perilous “crash” in the jobless rate.

US median wages have been stuck in neutral for decades now, so it’s difficult to understand why Fed officials would seek to stifle the job market just as it begins to show some semblance of life. A jobless rate of 4.3% has coincided with inflation that is actually moving further below the Fed’s target. Why not keep monetary policy tightening on hold until there’s some sign of price growth actually picking up?

There are many reasons the post-recession world has changed, ranging from more cautious firms and consumers to a reluctance to deliver strong fiscal stimulus on the part of the federal government.

Low inflation gives Fed officials the luxury of time in weighing how post-crisis employment conditions have changed. Despite Dudley’s impatience, they should use it.