The Federal Reserve will continue to tighten monetary policy in a bid to tame inflation, the central bank's Vice Chair Lael Brainard told members of an annual economic meeting. 

The strength of U.S. dollar inflation follows shocks from a global pandemic, constrained supply chains due to Russia’s invasion of Ukraine, and high economic uncertainty, said Brainard in a speech at the 64th National Association for Business Economics Annual Meeting in Chicago. The Federal Reserve accounts for high interest rate spillovers, as well as the strength of the dollar and that of foreign economic demand, she said. 

The cross-border effects of unanticipated changes to interest and exchange rates may amplify a lower risk tolerance, given fragile liquidity in core financial markets, said Brainard. This could pose challenges to policymakers if those risks materialized.

“Monetary policy will be restrictive for some time,” said Brainaird, who added that it will require a cumulative effort to reduce inflation rates.

GDP is down

Although supply is coming into better alignment with demand thanks to higher interest rates, real gross domestic product (GDP) has declined at an annual rate of nearly 1%, and real private domestic purchases also ticked down from an annual rate of 6.4% last year to only 1.3% so far this year, Brainard said.

Diminished consumer spending may be a result of lower household savings, which are estimated to be almost 25% down from previous quarters, Brainard said. It is also projected that the policy level rate will more than double by year's end when compared with expectations seven months prior. That, factored in with increases in interest rates and tightened broader financial conditions, means a limited rebound in the second half of the year with relatively flat GDP growth.

Signs of rebalancing

There are some silver linings. Brainard indicated strong wage growth and high rental and housing costs are expected to reduce high inflation. With demand moving from goods to services, declining core import prices and unsnarled supply chains, core goods are expected to return to some semblance of pre-pandemic pricing.

The pandemic brought margin increases for trade sectors that are anticipated to rebalance with increased inventories, eased supply constraints and cooling demand that Brainard said will help to reduce goods inflation.

Amid differing views on future inflation, a quarter of those surveyed expected prices to be around or less than current levels in the next 5-10 years, Brainard said.

In addition, tentative signs of a labor market rebalancing come from anecdotal reports that suggested the labor market is loosening, Brainard said.