Fed Faces Three Uncomfortable Truths

IMF deputy head Gita Gopinath

IMF deputy head, Gita Gopinath, recently highlighted three uncomfortable truths for monetary policy:

  1. Inflation is taking too long to get back to target.
    Financial conditions may not be tight enough and sustained high inflation could make the task of bringing inflation down more difficult.
  2. Central banks’ price and financial stability objectives conflict.
    Central banks can provide liquidity to struggling banks but are not equipped to deal with problems of insolvency which may be caused by a sharp rise in interest rates.
  3. We face more upside inflation risks.
    The past two decades of low inflation are over and the global economy faces inflationary pressures from:
    • On-shoring of critical supply chains;
    • Rising geopolitical tensions (with Russia, China and Iran);
    • Transition away from coal, oil and gas to low-CO2 energy sources (renewables & nuclear); and
    • Spiraling demand for critical materials needed to meet the above challenges.

Balancing monetary policy is going to be difficult, especially where prices are under pressure from a number of challenges. We expect central banks to tolerate higher inflation for longer in order to preserve financial stability.

Fed only expects to hit 2.0% inflation target in 2025

Fed Chairman Jerome Powell recently highlighted the above conflict between policies to tame inflation and maintain financial stability. During a recent ECB panel discussion, Powell indicated that he only expects the Fed to hit their 2.0% inflation target for core inflation in 2025.

The Fed Chair says job creation and real wage gains are driving real incomes and increased spending. That raises demand which in turn drives the labor market. (WSJ)

Unemployment increased slightly to 3.7% in May but remains near record lows. The tight labor market continues to fuel strong growth in hourly earnings.

Unemployment, Average Hourly Earnings Growth

Tighter monetary policy would drive up unemployment — as demand slackens and layoffs increase — and dampen inflationary pressures. But at the risk of financial instability.


Further monetary tightening is necessary in order to increase the slack in labor markets, weaken demand, and curb inflation in the short-term. But the required policy steps — rate hikes and QT — are likely to crash the economy.

Rather than create financial stability through vigorous monetary tightening, the Fed is likely to tolerate higher levels of inflation — above their 2.0% target — for a longer period.

A less-hawkish stance from the Fed would be bullish for Gold.