April 25, 2016
This is the second in a series of profiles of the members of the Federal Reserve Board’s Open Market Committee [FOMC]. The profiles will focus on their writings, public statements, and voting records as members of the FOMC.
Since her appointment as President of the Cleveland Federal Reserve (Fed) Bank in June 2014, Loretta Mester has been considered one of the Fed’s more hawkish members. Due to the voting structure of the FOMC, Mester has only been able to cast votes during the second half of 2014 and the early meetings of 2016. However, her public statements indicate that Mester has been more anxious than her colleagues to raise interest rates.
Mester’s most dovish moment came in 2014, when she supported the Fed’s decision to not raise the Federal Funds interest rate. In a September 2014 interview with the Cleveland Plain Dealer, Mester stated[1]:
“At this point, now, there is still more progress we need to make (before we raise rates)…I do believe it’s appropriate to keep interest rates at the zero to 0.25 percent range.”
However, Mester has argued that the Fed has a history of waiting too long to raise interest rates.[2] Even in her Cleveland Plain Dealer interview, Mester expressed a high degree of caution about waiting too long to raise rates:
“But I also think it’s prudent planning to be prepared to move rates…If things start moving faster than we anticipate, then I want to be prepared to raise rates.”
By early 2015, Mester was pressing for an increase in rates. In February 2015, in an article titled “Fed’s Mester Supports Rate Rise in First Half of 2015”[3], the Wall Street Journal indicated that Mester wanted to raise rates “in the next few months.” Later that year, Mester voted to increase the primary credit rate – more commonly known as the discount rate – from 0.75 percent to 1 percent[4]. In articles appearing in CNBC and Reuters from early 2016, she said that she supported her colleagues’ decision in December 2015 to raise the federal funds interest rate one-quarter of a percentage point[5,6], She also stated that she would support future rate hikes and wanted to draw down on the Fed’s balance sheet. In a January 2016 article in the Fiscal Times, Mester said that she would like to see more than four interest rate hikes during the coming year. The Fiscal Times article stated:
“[Mester] does not need to see clear evidence of inflation to back more policy tightening after an initial rate hike in mid-December. The Fed could act at any policy meeting, including one later in January, she said.”
One reason Mester said she supports future interest rate hikes is that “[o]nce we get away from zero on the funds rate, it makes sense to move.”[5]
But that has not been Mester’s primary rationale for raising rates. Rather, Mester has generally been in favor of raising rates because of her high estimates for growth:
“I’m probably a little steeper than [four interest rate hikes] in the near term, just because I have a higher growth forecast” (quote in the Fiscal Times).[7]
Mester expects the U.S. economy to grow at a 2.5 percent to 2.75 percent pace this year, slightly stronger than the 2.4-percent rate median forecast of her colleagues. That optimism allows her to view more than four rate hikes as appropriate, she said.[5]
Mester’s calls for rate hikes have typically been based on her predictions of rising inflation, a strong labor market, and strong growth. Each of these forecasts is discussed below. When combined with her belief that the economy has already been operating near potential, Mester’s forecasts for a quickly-strengthening economy have led to a belief that the economy will soon be operating at full capacity.
As early as February 2011 – when she was serving as the head of the Philadelphia Fed’s research department – Mester was worrying about inflation. She stated that “Federal government budget deficits running 7 to 10% are not sustainable” and that “Concerns about large looming fiscal deficits may increase inflation expectations.” She also predicted that inflation would return to 2.0 percent within the next two years[8]; the prediction was made five years ago, but inflation remains below 2.0 percent today.
In February 2015, Mester updated her view and predicted that inflation would rise to 2.0 percent by the end of 2016.3 Most recently, in January 2016 Mester stated that “we will gradually see inflation move back up to 2 percent.”[7]
When it comes to the labor market, Mester’s predictions for strong growth have been combined with the belief that the job market is nearly at full employment. As one impetus for raising rates, Mester has cited “solid labor market indicators, including strong payroll growth.”[5] In October 2014, Mester told New York Times reporter Binyamin Appelbaum that the “natural rate of unemployment” was 5.5 percent, meaning that, even at the time, the economy was near full employment.
While Mester has said she is basing her call for future rate hikes on her prediction for strong short-term growth, she has proven to be overly optimistic about growth in the past. In February 2011, Mester predicted that the economy would grow at a 3.5 percent rate in 2011 and 2012.8 (It ended up being 1.6 and 2.2 percent.) In the aforementioned New York Times article, Mester foresaw growth in 2015 and 2016 being 3.0 percent[9]; last year it was 2.4 percent.
In summary, President Mester has often supported higher interest rates based on her expectation of accelerating inflation, a tight job market, and strong short-term growth. To date these expectations have not been borne out in the data.
[1] Dixon Murray, Teresa. New Cleveland Fed President Loretta Mester talks about Ohio jobs, security breaches, downtown development and when interest rates will rise. September 2014. Cleveland Plain Dealer.
[2] McGrane, Victoria. 5 Things to Know about Incoming Cleveland Fed President Loretta Mester. February 2014.Wall Street Journal.
[3] Derby, Michael. Fed’s Mester Supports Rate Rise in First Half of 2015. February 2015. Wall Street Journal.
[4] 2015 Monetary Policy Releases. Discount and Advance Rates. November 2015. Board of Governors of the Federal Reserve System.
[5] Cox, Jeff. Fed’s Mester: ‘Gradual’ rate hikes to continue. February 2016. CNBC.
[6] Spicer, Jonathan and Ann Saphir. Fed’s Mester strongly backs U.S. rate hike as prudent first step. January 2016.Reuters.
[7] Spicer, Jonathan and Ann Saphir. Fed’s Mester prefers a bit quicker U.S. rate-hike pace. January 2016. Fiscal Times.
[8] Mester, Loretta. The Economic Outlook, pages 17-19. February 2011. 6th Annual Temple University Fox School of Business Leadership and Professional Development Seminar.
[9] Appelbaum, Binyamin. Q. and A. With Loretta Mester: Optimism at the Fed. October 2014. New York Times (The Upshot).
