Economists are beginning to say enough is enough. The Fed might continue to pause from another rate hike in their November FOMC meeting because the latest inflation data show a continued decline, but not in December.
“Although inflation has come down from the peak reached last year, it is still too high,” New York Fed President John Williams said in a prepared speech. “We still have a ways to go to fully restore price stability.”
To borrow from some economists who fear the Fed is getting the causes of inflation wrong and thereby keeping interest rates too high, the current inflation surge was caused by the pandemic, stupid!
Major economists such as former White House Chief Economist Jason Furman and Nobel laureate Paul Krugman have spoken about the dangers of prolonging higher interest rates, despite the rapid inflation decline.
“The question now is whether we’ll get a recession anyway — basically, whether Fed tightening will produce an unnecessary recession,” says Krugman. “And the picture there is very muddy. Milton Friedman’s famous line about “long and variable lags” has come in for a lot of questioning lately, with some suggestions that the lags may have gotten a lot shorter. If the lags are long, we may stumble into a recession; if not, not.”
Furman’s assertion is that wage growth can’t be a major determinate of inflation as it was in the 1970s, since it is still below the longer-term trend line.
“How are real wages doing? Most measures show they are up since prior to the pandemic but are still 3-5% below their immediate pre-pandemic trajectory.”
Yet listening to Fed Chair Powell, you would think most of the Fed Governors believe it was caused by higher wages, since Econ 101 postulates that wages comprise some two-thirds of product costs, therefore costs will rise or fall in line with wages.
That has been an economic truism since the 1970s, even though there was an Arab oil embargo in 1973 that brought shortages and sky-high gas prices leading to the so-called wage-price spiral that has traumatized the Fed since then.
The real question should be why are so many meetings necessary to make the point that inflation should come down further?
The Federal Reserve Governors convene eight official vote-taking meetings per year after which they broadcast their intentions for policy—whether to raise, lower rates, or stand pat. This is really interfering with Wall Street’s own internal processes and the actual time lag needed for policy actions to take effect that determine the direction of inflation, causing the wild price fluctuations we see today.
Would the markets behave differently with fewer Fed pronouncements? Fed officials have been acting preemptively before seeing the results of their policies for decades, which let us not forget includes maximizing employment as well as price stability.
Yet today we have the COVID pandemic causing the product shortages that led to the current inflation spike, followed by the Ukraine-Russian war causing further shortages. But inflation has been declining anyway, much more so than in the 1970s.
The favored measure of inflation, the Personal Consumption Expenditure Index (PCE) that measures a broad spectrum of products and services, has been declining fast. From the same month one year ago, the latest PCE price index for August increased 3.5 percent, per the FRED (St. Lous Fed) graph, down from its 7.1 percent peak in June 2022.
The danger with comparing it to the only analogy the Fed seems to come up with, the 1970s and the Arab oil embargo, is the damage it causes to wage and salary earners which comprise almost 80 percent of the adult work force.
Could the fear of not being taken seriously be the reason for so much Federal Reserve jawboning and unnecessarily high interest rates? Raising interest rates too high for too long has precipitated at least eight of the ten recessions since 1960, harming economic growth as well as household incomes.
Harlan Green © 2023
Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen
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