It is possible to reduce inflation without a recession, says Fed's Loretta Mester

Loretta Mester, president of the Cleveland Federal Reserve, said Friday that higher interest rates will likely be needed to bring inflation back to acceptable levels in the near future.

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Mester, in an interview with Trade Algo, said she believes the central bank should raise the benchmark interest rate above 5% and keep it there for a long period of time in order to be successful. At the moment, the fed funds rate, which sets the rate at which banks charge each other for overnight borrowing, but spills over into many forms of consumer debt, is in a target range of 4.5%-4.75%, which is well in line with where it was in the last few years.

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“There is no doubt that we are going to have to raise interest rates above 5% over the next few years,” she told Trade Algo. "We'll figure out how much above that is. As far as how the economy evolves over time, that is going to be determined by how the economy develops. However, I do believe that we need to be somewhat above 5% and maintain that level for a period of time in order to get inflation on a sustainable downward path to 2%.”

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Earlier this week, Mester made news by revealing that she was among a small group of Fed officials who, at the recent Jan. 31-Feb. 1 Federal Open Market Committee meeting, wanted a half percentage point rate hike rather than the quarter percentage point hike approved by the panel.

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In spite of the fact that she is not a member of the rate-setting FOMC this year, she has input into the decisions that are made. The committee will meet again in March, but she is still unsure whether she will push for an increase of half a point.

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"I don't prejudge," she replied. “This was a tactical decision made at the meeting."

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There is a general consensus among economists that the Fed will not be able to achieve its inflation target without tipping the economy into a recession in the process. In the fourth quarter of 2022, GDP grew 2.7%, and in the first quarter of 2023, it is expected to grow at about 2.5%.

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As long as the economy does contract, Mester believes it will not be a severe downturn even if it does contract. Furthermore, she expressed hope that the Fed would be able to achieve its goal without crushing a labor market that has been surprisingly resilient despite all the rate increases that have been made.

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“In fact, I believe that we can have both of these things in the current labor market. It is possible to have a healthy labor market, and we can get back to price stability as soon as possible," she suggested. “It is also very important to remember that if we want to maintain a healthy labor market over time, we must be able to get back to a stable price level.”

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It was scheduled that Mester would speak at a New York conference on monetary policy later on Friday.

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