The inflation rate for wholesale goods and services (PPI) is still declining, which will hearten the inflation doves after yesterday’s Consumer Price Index (CPI) seems to be stuck in a 3 percent range. So, the Fed has a dilemma, which one to choose and use to forecast future inflation?
The Producer Price Index for final demand rose 0.2 percent in March, seasonally adjusted, the U.S. Bureau of Labor Statistics reported today. The index for final demand increased 2.1 percent for the 12 months ended in March, the largest advance since rising 2.3 percent for the 12 months ended April 2023.
What? You mean wholesale inflation is already down to 2 percent? This annual cost of raw materials and services has been at or below 2 percent for a year and hit zero percent in June 2023 as the supply chains recovered.
So, where’s the inflation the Fed is worried about? It’s because of rising wages and the higher profits of producers (corporations) and distributors that took advantage of the supply shortages during the Covid pandemic are added into the Consumer Price Index.
So-called equivalent rents are also incorporated into the CPI. And that is a lagging indicator that is based on last year’s rents, which aggravates Realtors, because one reason for the housing shortage (and higher rents) is fewer new homes are being built, largely because of higher construction costs from the very high interest rates engineered by the Federal Reserve!
The NAR’s chief economist Lawrence Yun has been loudly complaining about this anomaly:
"March inflation figures were very bad, which also means bad news for interest rates. Consumer prices reaccelerated to 3.5%,” said Yun. “This is higher than the 2% target inflation, which raises eyebrows regarding the Federal Reserve's delay in cutting interest rates. The bond market immediately responded with high yields to compensate for the loss in purchasing power.”
“One strange data point is rent, Yun said, “which the official data shows at 5.8%. The unofficial data from the apartment industry indicates falling rent due to over-construction. If rent data calms, then overall inflation will automatically be lower. It is, therefore, possible to get to the 2% inflation target by year's end, even with bumps and delays."
Said rising wages are also one reason our economy is doing so well. Consumers continuing to shop is a sign of continuing prosperity, is it not?
So why do so many Fed Governors remain hawkish and want to continue the inflation fight, instead of dropping interest rates? It could push economic growth down into no growth territory, as economists and some Fed Governors are warning.
New York Fed President John Williams said Thursday that monetary policy "is in a good place," helping to restore supply and demand balance to the economy.
"There's no clear need to adjust monetary policy in the very near term," Williams told reporters after a speech in New York.
The Fed therefore has a dilemma, as I said—when to drop their interest rates without losing their credibility in fighting inflation?
Willem Buitner and Ebrahim Rehbari, two English economists, say first improve their forecasting methodology, in a Project Syndicate article:
“There is a vibrant debate about whether firms abnormally raised their profit margins in recent years. A recent Fed study finds that nonfinancial corporate profits rose to 19% over gross value-added in the second quarter of 2021, up from 13% in the fourth quarter of 2019. But once prices have risen and profit margins are high, they are less – not more – likely to rise further than before the large price adjustments. Normalizing energy prices, supply chains, and profit margins all contributed to the faster-than-expected decline in inflation in the second half of 2023.”
They then cite Fed Chair Jerome Powell, paraphrasing Winston Churchill, recently called forecasters “a humble lot – with much to be humble about.”
It may be the opposite lesson from the Great Recession when CPI retail prices plunged to a negative 2 percent in July 2009, in part because the Fed held their 5.25% maximum rate too long.
Inflation remained in the 2 percent target range for the next 10 years, but also did GDP growth, as budget debates and a government shutdown plagued the Obama administration, which meant badly needed infrastructure, technology and climate change legislation wasn’t passed until the Biden administration.
So, the Fed should pay more attention to PPI wholesale inflation that indicates the Fed is close to its inflation target, since even slightly higher inflation is helpful when higher growth is necessary to modernize the US economy.
Harlan Green © 2024
Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen
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