Fed's Daly: Inflation Not the Only Risk, Policy Must 'Exhibit Care'

Balancing Act: Controlling Inflation Without Economic Disruption

According to San Francisco Fed President Mary Daly, the Federal Reserve must exercise caution as it works to tame inflation. Speaking at the Commonwealth Club in San Francisco, Daly emphasised the necessity of restoring price stability without causing a painful economic disruption. Despite progress in lowering inflation, she highlighted that it is not the sole risk the economy faces.

The Dual Challenge: Inflation and Unemployment

Daly pointed out that reducing inflation further will likely require restraining demand, a move that could potentially impact the labor market. Currently, the unemployment rate stands at 4%, which is below long-term sustainable levels. However, future labor market slowing could lead to higher unemployment. To mitigate this risk, Daly stressed that the Federal Reserve must remain both vigilant and adaptable in its approach.

Policy Flexibility: Conditional and Ready for Multiple Paths

The Federal Reserve's policy, according to Daly, must be "conditional" and ready to adapt to various possible scenarios. This could include maintaining current interest rates if inflation remains stubbornly high or cutting them if the labor market weakens more than anticipated. The Fed left interest rates unchanged in the 5.25%-5.5% range earlier this month and indicated that rate cuts this year might be fewer than previously expected.

The Importance of Careful Navigation

Daly did not specify how many rate cuts might be necessary but underscored the need for a careful and measured approach. "If we continue to see gradual declines in inflation and a slow rebalancing in the labor market, then we can normalize policy over time, as many expect," she noted.

Recent Inflation Data: Mixed Signals

Inflation, as measured by the personal consumption expenditures price index, was 2.7% year-over-year in both April and March, up from 2.5% in the preceding months. Recent forecasts suggest that the index may not have increased from April to May. Daly acknowledged the mixed signals from inflation data, describing it as "bumpy" and insufficient to inspire full confidence. "Recent readings are more encouraging, but it is hard to know if we are truly on track to sustainable price stability," she said.

Conclusion: Vigilance and Openness Are Key

In conclusion, Daly's remarks underscore the delicate balance the Federal Reserve must maintain as it seeks to control inflation without triggering higher unemployment. By remaining vigilant and open to adjusting policies as needed, the Fed aims to navigate the complex economic landscape and ensure long-term stability.