Fed’s Lael Brainard Warns on Inflation, Financial Stability Risks

Resolving those imbalances by slowing demand with higher rates “will be easier the more supply improves in markets for commodities, labor, and key intermediate inputs, as is generally expected,” said Ms. Brainard. “But there is a risk supply disruptions could be prolonged or aggravated by Russia’s war against Ukraine, Covid-19 lockdowns in China, or weather disruptions.”

The Fed and other central banks are raising rates aggressively to prevent consumers and businesses from anticipating high inflation to persist, which could fuel a self-fulfilling cycle of stronger price increases, said Ms. Brainard.

Sharp dislocations in British government-debt markets this week prompted the Bank of England to purchase unlimited amounts of longer-duration securities to prevent broader fire sales of debt.

Ms. Brainard didn’t refer specifically to developments this week in the U.K. in her prepared remarks, but said the Fed was “attentive to financial vulnerabilities that could be exacerbated by the advent of additional adverse shocks.”

Fed rate increases are already slowing demand in interest-rate sensitive sectors such as housing, but Ms. Brainard said it would take time for the full effect of higher borrowing costs and tighter financial conditions from working through different sectors of the economy to bring inflation down.

Ms. Brainard pointed to signs that the Fed’s policies will soon achieve their desired effect by highlighting how “real” or inflation-adjusted interest rates have now risen solidly above zero for all but the shortest maturities of U.S. government debt. Coming Fed interest-rate increases and an anticipated deceleration in inflation will soon push very short-term interest rates into positive territory on an inflation-adjusted basis, she said.

“Monetary policy will need to be restrictive for some time to have confidence that inflation is moving back to target,” she said. “For these reasons, we are committed to avoiding pulling back prematurely. We also recognize that risks may become more two sided at some point.”

The Commerce Department’s personal-consumption-expenditures index, the Fed’s preferred inflation gauge, rose 6.2% in August from a year ago. The index of so-called core prices, which excludes volatile food and energy items, rose 0.6% in August from July. Core inflation had been flat in July from June. Core inflation increased 4.9% from a year earlier in August, up from 4.7% in July.

Ms. Brainard devoted most of her speech to financial stability risks that central banks around the world could face as they raise rates rapidly, especially as many countries face very high inflation. They may face added pressure to raise rates to prevent their currencies from depreciating as the Fed and others lift borrowing costs.

She cited risks that countries with high corporate and government borrowing levels could see growing concerns about debt sustainability, which could be exacerbated by currency depreciation. Rising financial volatility could also spur financial institutions to scale back borrowing and risk taking, which could amplify market volatility.

Ms. Brainard also flagged the risk that reduced liquidity, a catchall term for the cost of quickly converting an asset into cash, in certain financial markets could further amplify financial shocks.

Write to Nick Timiraos at nick.timiraos@wsj.com