[Turning Point Approaches] Professor Misikin: "US Fed Must Raise Interest Rates to 6% Range"

[Asia Economy New York=Special Correspondent Joselgina] "The U.S. Federal Reserve (Fed) must slow down the economy enough to control inflation, and to do so, it must raise the benchmark interest rate to around 6%. Everything points to a recession."

Frederic Mishkin, a leading expert in monetary economics and professor at Columbia Business School, said in an interview with Asia Economy ahead of the 2023 New Year, "There is no way to avoid a recession," citing the following reasons: ▲Fed's delayed tightening ▲ongoing shocks from the Ukraine war ▲China maintaining its zero-COVID policy for too long.

Professor Mishkin, who has long warned of Fed's mistakes, emphasized, "The interest rate must reach at least the 5% range before the effects of last year's cumulative tightening are confirmed in the economy." This is an argument that the Fed, which raised U.S. rates to 4.25-4.5% last year, must continue high-intensity tightening in the new year. He said, "Because the labor market is still strong, more restrictive policies are necessary," and suggested, "The terminal rate will probably be around 6%." This far exceeds the Fed's dot plot forecast for this year of 5.00-5.25% (median 5.1%) as well as the projections of major investment banks.

Mishkin, who was once considered a candidate for Fed chair, is an economic expert who has served as a Fed governor, advisor to the International Monetary Fund (IMF) and World Bank (WB). He also has ties to Korea, having advised the Bank of Korea and the Financial Supervisory Service. However, in this interview, Mishkin was reluctant to comment on the Bank of Korea's response to the Fed's tightening, saying, "More information is needed."

Below is a Q&A with Professor Mishkin.

- Concerns about a recession in 2023 are rising. Will the U.S. fall into a recession?

▲ My answer is "Yes." There is a very high possibility of a recession in the U.S. in 2023. By making the surprising decision to raise rates by 0.75 percentage points in June last year, the Fed effectively admitted its mistake. The central bank's delayed response means it must raise rates much higher than to simply establish credibility in monetary policy. Under these circumstances, the possibility of a soft landing is extremely low. In other words, because the Fed raised rates too late, the chance of a recession has greatly increased. That is the first reason. Second, Russia's invasion of Ukraine has had a very negative impact on the global economy. It has caused a double whammy affecting both demand and supply. Europe is entering a recession due to high energy prices. Third, China made a big mistake. China maintained its zero-COVID policy for too long. All of this fundamentally points to a recession. There is no way to avoid it.

- How severe do you expect the recession to be?

▲ I do not think it will be severe. Typically, a severe recession occurs when household and corporate balance sheets are problematic, as in the Great Depression. Unemployment will rise in the future, but it will not be the kind of recession where it surpasses 10%.

Currently, there are no signs that we are already in a recession. Fundamentally, the labor market is very strong. However, these indicators mean the Fed must continue tightening. Ultimately, the Fed will tighten more aggressively than it has indicated, and the result will be a recession.

- What should the Fed do?

▲ It must become stricter. As Fed Chair Jerome Powell said, what matters now is the ultimate level the interest rate reaches. The Fed must reach that level faster than planned. Even if inflation is expected to fall to the 3% range, the rate must reach at least the 5% range before the cumulative tightening effects are confirmed in the economy. This is still not enough. The economy must be slowed enough to control inflation, and to do that, rates must be raised to around 6%.

- Are you saying the terminal rate will be 6%?

▲ It will probably need to be raised to around 6%. If we are lucky, inflation might fall faster than I expect. But I do not think that will happen. The labor market is still very strong. To bring inflation down to the 2% target level, more 'restrictive' policies are necessary. The terminal rate will definitely exceed 5%. What happens next depends on what occurs on the inflation front.

Again, the Fed must be more hawkish. The only way to control inflation now is for the Fed to raise rates enough to convince people that a severe recession is very likely.

- Comparing the current situation to the stagflation of the late 1970s, should Chair Powell act like then-Chair Paul Volcker?

▲ I have been warning since April 2021 that the Fed would be in trouble, and that has become reality. Some stagflation will be confirmed with high inflation and high unemployment. But we are not yet in the situation where rates must be raised to 22%, as in the late 1970s. Back then, inflation was double-digit and was not simply caused by supply issues. Remember that the environment Volcker faced was similar but much worse than now. Volcker had to take out the baseball bat. But now, that is not the case.

- When do you expect supply chain disruptions to improve?

▲ There are too many wildcards, but I will talk about China. Zero-COVID is really nonsensical. Maintaining this policy, which is like a whack-a-mole game, for so long was a mistake. Beyond COVID-19, it is not good that President Xi Jinping tries to control everything.

- There are many concerns about the global economic impact under Xi Jinping's third term.

▲ I was really worried when President Xi was re-elected. He is overturning many successful policies under the Chinese Communist Party as well as many policies before he took power. This is fundamentally very nationalist. It can be very dangerous not only from a global economic perspective but also geopolitically. Russia is also concerning in terms of deglobalization and nationalism. Moreover, China’s case will inevitably have a big impact on Korea. Korea will become very vulnerable.

- The cryptocurrency market is still facing aftershocks from the FTX bankruptcy.

▲ I think cryptocurrencies have always been overvalued. Cryptocurrencies are not money. But many believed cryptocurrencies would become money in the future. Now we are seeing that cryptocurrency exchanges were not properly regulated. Many people suffered losses. This shows the overvaluation risk of cryptocurrencies. However, since this incident did not affect the general financial system, it will not escalate into a very serious problem.

- What is your outlook for the U.S. dollar this year?

▲ The reason the dollar has been strong is that the Fed’s tightening has started and global economic concerns have increased. The dollar soars in such times. I cannot provide a specific forecast for this year, but given the geopolitical situations such as China’s condition and the Ukraine war, the dollar’s strength is not surprising.