Fed Chair Jerome Powell just said Americans must now feel the pain if the Fed is to bring inflation back to its long-term 2 percent annual target. But why? The 2 percent inflation rate that prevailed since the end of the Great Recession resulted in higher unemployment and less than 2 percent annual economic growth—not enough growth to lower the unemployment rate to what it is now—3.5 percent.
Instead, it may be record corporate profits doing the most damage in boosting inflation and must be tamed.
In fact, it was difficult work to bring the inflation rate back to 2 percent, since the danger was too-low inflation and the danger of disinflation, or even deflation at the time, because Asian countries could produce an oversupply of consumer goods, keeping prices low and more American workers unemployed.
Now we have too high inflation because the COVID pandemic closed economies that produced those cheap supplies, so we have the supply and supply-chain problems with a Ukraine-Russian war adding to the scarcity.
In addition, corporate profits are at all-time highs. MarketWatch’s economist Rex Nutting highlighted the record growth since World War Two:
"After-tax corporate profits rose at a 41% annual rate after inflation in the second quarter of the year and have risen at a 17% annual pace since the pandemic recession ended two years ago. Meanwhile, the inflation-adjusted purchasing power of individuals’ after-tax income has fallen for five quarters in a row.”
In fact, those record profits have been at the expense of workers’ salaries, says Nutting. The data show that hourly compensation declined at a -1.5 percent annual rate in the first half of the year after adjusting for inflation and is now down -2.3percent since the end of the pandemic recession.
So, Fed Chair Powell may be barking up the wrong money tree when he said the Fed might cause substantial pain to consumers more than businesses. What if it isn’t rising wages, but corporate profits that are enabling corporations to boost prices, rather than paying their employees more?
“Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” he added.
Consumers’ personal consumption expenditures have barely keep up with rising prices, which means they will have little effect on future inflation. Personal Consumption Expenditures rose just 0.1 percent in July, vs. being as high as 8.6 percent in April 2021 when their pockets were bulging with the pandemic relief payments.
So let’s not blame the consumer for the inflation that the Fed wants to tame, who is fighting so many other battles. The new Inflation Protection Act enacting a minimum 15 percent tax rate on corporations and one percent on stock buybacks will hurt those that can afford it--record corporate profits that puts the blame game where it belongs.
The Fed could also continue downsizing their holdings of securities. Selling more of their $4 trillion plus in Treasury securities ($4.97 trillion on June 8) could raise interest rates more gradually, thus avoiding the danger of another recession.
On June 1, 2022, the Federal Reserve initiated the process of reducing the size of its balance sheet to address rising inflation. According to a May press release, the Fed will initially cap its monthly purchase of Treasury securities at $30 billion for June, July and August – for context, the Federal Reserve purchased an average of $80 billion in Treasury securities per month between March 2020 and March 2022. The cap is set to increase to $60 billion in September and will likely remain at that level through the end of calendar year 2023. The Federal Reserve will also reduce its holdings of mortgage-backed securities over the coming months.
Maybe it’s businesses that should be feeling more pain, rather than workers?
Harlan Green © 2022
Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen
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