Fed's Mester and ex- NY Fed's Dudley diverge on policy views

The debate around whether the US central bank's policies were too 'accommodative' or not and the cost-benefit trade off attached to them was continued on Tuesday.

In remarks to Yahoo Finance, the head of the Federal Reserve bank of Cleveland, Loretta Mester, defended those policies, arguing that they were taking into account the "new economic environment".

"I don't view it as we’re taking it on more risk. I view it as using the strategies that will achieve our goals more effectively in the new economic environment we're operating in," she said,

In response to the gigantic damage sustained by the US jobs market during the pandemic, the Fed had set a course aimed above all at encouraging as quick a return to normality, which it believed was the best way to minimise the long-term 'scarring' effects on the supply side of the economy by as much as possible.

But in recent weeks in particular, more than a few economists had apparently begun to float the possibility that perhaps the monetary authority should be laying the groundwork for tweaking its stance towards a less accommodative one.

That was the case on Tuesday of William Dudley, a former boss of the New York Fed.

Dudley reportedly told Bloomberg Radio that the Fed's policy framework meant that it would be late and would need to play catch up - meaning that it would need to hike short-term interest rates more than was currently priced into financial assets.

"I think the thing people don't really fully appreciate is, when they actually have to catch up, the level of short-term rates will be much higher than the 2% rate that is currently priced in financial markets," Dudley said.

He also referred to the "gap" between where rates are now and where they would need to be as "big".

"I am just highlighting where the risks lie. People in the financial markets just need to be cognizant of those downside risks."