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Mester: Fed should avoid overreacting to inflation

The Federal Reserve should avoid overreacting to stronger inflation data in the coming months and communicate that it is comfortable with some overshooting of its 2% target, Cleveland Fed President Loretta Mester said March 26.

Mester, who voted for last week's decision to raise interest rates, said she supports further rate hikes in 2018 as the U.S. central bank looks to sustain the country's economic expansion. The Fed's current approach of gradual rate hikes, she said, represents a "careful balancing" as it tries to ensure the labor markets remain strong but inflation does not rise too much.

Inflation, she noted, has remained below the Fed's 2% target but has shown indications that it will pick up and reach this goal over the next year or two.

As that happens, she said, the Fed should avoid overreacting to any data showing stronger inflation increases. She said mild and temporary overshoots of inflation "should not be a cause for concern," just as the current undershooting has not been a major issue.

"One of the risks of having inflation under-run the 2% goal for so long is that inflation expectations could have become unanchored. That didn't happen," she said in a speech at Princeton University. "Now, as inflation firms, it is equally important that monetary policymakers continue to convey through policy communications and decisions our commitment to achieving our dual mandate goals."

Mester noted that business sentiment remains high and said firms will benefit from tax reform passed in December 2017 and a deal from Congress to boost federal spending. She said while the effects of both actions are not totally clear yet, surveys from the Cleveland Fed indicate some businesses are planning on using their tax savings for further investments.

Still, she said, the positive outlook may be dampened by the ongoing discussions around U.S. tariffs and potential retaliation from other countries, uncertainties that "may not be resolved quickly."

"I am monitoring trade developments, and while I see them as a risk to the forecast, at this point they have not led me to change my outlook for the overall economy," she said.

Mester also said she has been surprised that despite tight labor markets and a 4.1% unemployment rate, wages have not been rising substantially. She said those developments suggest that the labor market "may not be as tight as I had been assuming."