The Federal Reserve may need to raise interest rates at least three times this year and begin running down its balance sheet to respond to a tight labor market and inflation that is persistently high and more broad-based, Cleveland Fed President Loretta Mester said on Tuesday.
"If the economy in March looks like it does today and the outlook is similar ... then I would support moving the funds rate up at that meeting and starting to move back from some of the extraordinary accommodation we needed earlier in the pandemic," Mester said during an interview with Bloomberg TV.
Final decisions on monetary policy will depend on what is happening with the economy and be based on how the coronavirus pandemic plays out, Mester said. But Fed officials may need to recalibrate policy now to address inflation that is "well above" the U.S. central bank's target, she said.
Mester said she expects more workers to return to the labor market and for the labor force participation rate to rise over time, but added that policymakers cannot ignore the "tightness" that is playing out in the short term.
Fed officials are expected to begin debating strategies for removing the accommodation provided during the pandemic when they gather for their next policy meeting in two weeks. That involves raising interest rates and creating a plan for reducing the central bank's more than $8 trillion in bond holdings.
Mester said she thinks the Fed may be able to move more quickly when running down its balance sheet now than it has in the past because the economy is strong and its bond holdings are larger than they were previously.
"I'd like to ... set a path for the balance sheet," Mester said. "That will reduce accommodation and then we'll use our policy tool, the Fed funds rate, as our active tool."