Fed chair Jay Powell: policymakers’ forecasts of future rate increases should be taken with ‘a grain of salt’ © Financial Times

Elevated inflation will compel the Federal Reserve to raise US interest rates at least twice by the end of 2023, according to a new poll of leading academic economists for the Financial Times.

The inaugural survey conducted by the FT and the Initiative on Global Markets at the University of Chicago’s Booth School of Business points to a potentially more hawkish path for monetary policy than indicated by the Fed’s chair, Jay Powell.

The economists’ views align closely with the “dot plot” of Fed officials’ own forecasts for when and how quickly rates will have to rise from their current level near zero, as the US economy rebounds from the pandemic and inflation runs ahead of the long-term average targeted by the Fed.

Publication of the latest dot plot sent a jolt through markets earlier this month, as policymakers moved up their timing for expected lift-off, but Powell and other members of the Fed leadership intervened later to insist they would be patient in keeping monetary policy highly accommodative.

The FT-IGM US Macroeconomists Survey polled 52 academic economists on the likelihood that the Fed’s main policy rate would indeed be higher by 0.50 percentage points by the end of 2023, as the dot plot indicated. A majority said the likelihood of a move of that size or greater was above 75 per cent, and a large minority put it as high as 90 per cent.

Three economists said it was a certainty.

Strip plot showing economist's projections for rate hikes by the end of 2023

The survey underscores the challenge facing the central bank to convey a clear message about its evolving monetary policy stance. Powell warned that dot plot forecasts of future rate increases should be taken with “a grain of salt”, but other officials have begun to float earlier timelines for the first rate increases.

“As inflation goes up and the economy improves, the traditional hawk-dove differences across the Federal Open Market Committee are going to start to reappear,” said Alan Blinder of Princeton University, who was a vice-chair of the Fed in the 1990s and participated in the survey. “You are seeing it now, and you are going to see more of it.”

Blinder said he forecast an interest rate increase as early as 2022.

FT-IGM survey respondents see inflation as the biggest driver of Fed officials’ changing thinking on the timing of rate rises, citing it as the main factor more frequently than the improving outlook for the US jobs market or rising house prices.

Consumer prices have surged this year beyond even some of the loftiest estimates. Core PCE, the inflation measure targeted by the Fed, was running at an annual rate of 3.4 per cent in May, its highest in 29 years, as strong demand for goods and services in the improving economy collided with widespread supply chain constraints.

The FT-IGM survey, which ran between June 25 and June 28 and will be conducted regularly throughout the year, shows that economists are highly attuned to the risk of elevated inflation. Survey respondents’ median forecast for core PCE at the end of this year was 3 per cent — the same prediction as the median Fed official.

But two-thirds of the respondents said it was “somewhat” or “very” likely this metric would still exceed 2 per cent on a year-over-year basis by the end of 2022. The median forecast of Fed officials is for 2.1 per cent at the end of next year.

“It is hard to think of a more pro-inflation environment,” said Nicholas Bloom, an economist at Stanford University, who participated in the survey. “The Fed has been as aggressive as it can be in promoting growth, fiscal policy is incredibly relaxed and there are supply constraints.”

Despite the “perfect storm” that Bloom said has formed to push consumer prices higher, he dismissed concerns that inflationary pressures would get out of hand in the long-run, not least because the Fed is on hand to act.

Three-quarters of the FT-IGM survey respondents said it was unlikely market expectations for long-term inflation would rise significantly to over 3 per cent by the start of next year. Expectations are currently for long-term inflation of 2.3 per cent.

“An essential part of the Fed maintaining their credibility is being responsive to the incoming data,” said another respondent, Karen Dynan of Harvard University.

Bar chart showing economists' responses to the question "What is your estimate of the likelihood that five-year five-year forward inflation compensation will exceed 3 percent at the end of the first week of January 2022?" in the FT-IGM survey of more than 50 economists (Five-year five-year forwards indicate what five-year inflation expectations will be in five years’ time, derived from the expected difference between yields on Treasuries and inflation-protected government bonds.) Three-quarters of respondents say it is 'very unlikely' or 'somewhat unlikely' that inflation expectations will exceed 3% in 2022.

The central bank has already begun discussing when it will begin scaling back its $120bn monthly asset purchase programme, which officials have pledged to maintain until they achieve “substantial further progress” on their goals of 2 per cent average inflation and full employment.

The FT-IGM survey showed substantial disagreement about the outlook for economic growth in 2021, even with almost half the year in the rear-view mirror.

The median forecast was for a gross domestic product rebound of 6.5 per cent, after the economy contracted 3.5 per cent last year. But the economists were also asked to set out a plausible range of outcomes, and these more often skewed to the downside than the upside.

The high degree of variation suggests “there is considerable uncertainty about how fast service sectors will bounce back, whether labour market shortages will hamper growth and how savings [and] consumption will respond once fiscal stimulus is dialled down”, said Allan Timmermann, a professor at University of California at San Diego, who helped design the survey.

Box plot showing economists' forecasts for US GDP growth in 2021, according to the FT-IGM survey of more than 50 economists. The median forecast is 6.5%, however there is substantial variation in the predictions. 18 economists believe the tail risk skews to the downside, while 7 (who are relatively gloomy in their forecasts) see more upside potential. The rest believe the risks are evenly distributed.


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