Fed’s Pause Will Allow Inflation to Linger
Starting last June, I thought the Fed had it right and was fully prepared, as they said, to make price stability their top priority. After seven consecutive substantial interest rate increases, they slowed down. Instead of a seventy-five basis point rate increase they slowed to twenty-five basis points increases and the last time a zero rate increase. This pause will allow inflation to linger and likely increase somewhat by late summer.
In 2021 and into the first quarter of 2022, the Fed had a shockingly irresponsible expansionary Money Policy. The economy was growing at a 6% rate and the Federal Government was deficit spending nearly $3 trillion for the second consecutive year.
By keeping interest rates near zero and by increasing the money supply an extra $240 billion per month through the Fed’s government bond buying, there was huge excess demand created in the economy. The result would obviously be much higher prices.
Finally in June 2022, after inflation had peaked at an annual rate of 9.1% the Fed got aggressive. Fed chair Jerome Powell said that price stability would be the top priority of the Fed. At that time, it looked like the Federal Funds Rate would have to hit at least 6% to permanently bring inflation down to the 2% level that we all can easily live with.
Ronald Reagan said that inflation is a horrible cancer that must be aggressively treated in the early stages. If not, inflation spreads and gets locked into inflated wage contracts and consumers’ psychology. This is what happened in the 1970s.
The proper action for the Fed should have been to continue with their seventy-five basis point rate hikes at least one more time. That would have resulted in a 6% Federal Funds Rate. Instead, the Fed moved less aggressively and then paused.
It is very difficult to get accurate forecasts for future inflation. Much of the uncertainty has to do with energy prices. Energy accounts for about 30% of the CPI and Oil prices have remained under $75 per barrel. Worldwide demand is weak mostly because China is having a tough time fully restarting its economy after the COVID lockdown.
If oil prices rise to $100 per barrel, as some economists have forecasted, our inflation gets much worse. If oil prices stay about the same, then our core inflation rate is still over 5.3%. The longer it stays in that range the tougher it will be to bring that number down.
The Fed says that although price stability is still their top priority, they are concerned about their second and third goals which are full employment and growth. In other words, they want to avoid a recession.
They said they were aiming for a “soft landing” where they reduce inflation and just slow the economy down but avoid recession.
That may prove to be very difficult. And, if they are wrong, the inflation problem worsens.
Chair Powell has projected about a two million worker increase in the unemployment number because of the Fed’s monetary policy. That number could, however, be overstated.
Currently, there are about 10 million job openings and only about 6 million unemployed workers. That’s why we have a labor shortage. During a potential recession, this is actually helpful.
As the economy slows and revenue falls businesses will first stop looking to fill an open job before they lay off a worker. Also, with all of the job openings, unemployed workers may find that it is easier to find another job. Some economists have referred to the forecasted recession as a “full-employment recession.”
It looks like the pain from the recession may not be that great.
There is still too much demand in the economy. The Fed’s policy has certainly helped, but the Federal Government is still overspending by $1.6 trillion this year. Also, consumers seem to be less resistant to higher prices than in the past.
The economy is still adding jobs at a high rate. And retail sales are increasing quickly. Consumers are spending, even though prices are rising.
Interest rates need to go up another 75 basis points. Instead of pausing the Fed should be more aggressive. Inflation is a cancer and must be treated early and aggressively.
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