Ex-Fed Economist Bill Nelson on Federal Reserve Strategy

WASHINGTON — Bill Nelson has experienced the workings of the Federal Reserve from both sides.

Nelson is the chief economist of the Bank Policy Institute, a trade group for US banks. Earlier in his career, he was an economist at the Federal Reserve and rose to become deputy director of the Monetary Affairs division, which directs the Fed’s rate decisions.

Like many economists, Nelson says the Fed has taken too long to raise interest rates this year. He favors a more forward-looking strategy from the Fed, which has recently made some sharp policy changes in response to the latest economic data. The Associated Press recently spoke with Nelson.

Q: Fed officials, including Chairman Jerome Powell, have acknowledged that in hindsight, they could have started raising rates sooner than they did. What do you think of their policy now?

A: They are on the right track. I’m not 100% sure they’re following the right strategy, but I think the path they’re taking is a good one.

Q: What do you disagree with?

A: Part of the problem that left them where they are today was initially the desire to focus on realized inflation rather than the outlook for inflation. This is understandable, as the outlook has been very difficult to predict. But monetary policy should be a forward-looking exercise, based on forecasting. It cannot be based on looking out the window. Although they have now adapted to a fast pace of tightening, they still seem to react to what they see outside the window instead of looking ahead. You could be making a mistake – either way – by looking at current inflation. Inflation may remain high, even if spending declines. And in light of that, you don’t want to keep raising interest rates if you’re already slowing growth. But on the other hand, there will be a decrease in inflation simply because the temporary components come through. And you don’t want to respond to that by stopping interest rate hikes.

Q: Is the Fed fully focused on raising interest rates, or will it pull out soon for fear of rising unemployment and recession?

A: Sometimes the dual mandate can give conflicting directions about what the Fed should do: the need to have inflation around 2% and the unemployment rate close to full employment. But this is not one of those moments. The labor market is very tight and inflation is very high. They have to position monetary policy in such a way that it is very restrictive in terms of economic growth. They don’t want to cause an unnecessarily deep recession. What they are aiming for is a position with enough restraint to slow the economy and curb inflation.

But I am confident that when there are more signs of slowing growth and signs of falling inflation, they will both weigh together.

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Interviewed by Christopher Rugaber. Edited for clarity and length.