Federal Reserve policymakers should not waver in their pursuit of 2% inflation but talk less about it.
As measured year-over-year by the consumer price index, inflation slowed from 9.1% in June to 7.7% in October but the Fed faces tough challenges beyond the reach of monetary policy.
Sanctions on Russian oil exports may instigate tighter petroleum supplies, the war in Ukraine is already squeezing grain and fertilizer markets, climate change is disrupting global agriculture, and transportation networks and electric vehicles will require prodigious amounts of lithium and other scarce metals.
China’s ambitions in the Pacific, industrial policies, and strict COVID policies are inspiring a decoupling of U.S.-Chinese commerce.
Overall, about half of the recent surge in inflation may attributed to supply-side issues.
Yet, Fed Chairman Jerome Powell recently asserted, “We have the tools that we need and the resolve it will take to restore price stability.” It would be curious to know how the Fed raising interest rates can bring peace to the Ukraine, remove CO2 from the atmosphere, speed up mine and smelting investments, and alter China’s imperial ambitions.
Since Ben Bernanke, the Fed has tried to be more transparent about its intentions.
Policy surprises beget instability in financial markets and upset planning by businesses and households, but transparency can create more havoc when communications are tentative or inconsistent.
Lousy crystal ball
The Fed cannot know where it is going next month or next year without knowing whether inflationary pressures will persist or subside. Along with Treasury Department, it’s not any better than private analysts at anticipating wars, weather patterns, the politics of developing country mineral development, or the machinations of autocrats.
When inflation was less than the Fed’s 2% target, then-Chairman Janet Yellen told us deflationary pressures were temporary—they weren’t. As the economy recovered in 2021, Powell told us inflationary pressures were transitory and that turned out false.
The Fed appears enamored by the notion that consumer and financial market expectations of future inflation are a good indicator of where inflation is headed.
Let expectations get out of control and inflation will spiral like a cyclone. Consumers anticipating steep price increases, for example, will move up durable goods purchases and home improvements that Fed monetary policy may be trying to slow.
The year-over-year increase in the CPI jumped from 1.4% to 5% from January to May 2021. In May 2020, expected inflation one year hence as reported by the New York Federal Reserve household survey was 3% and the bond market as tracked by the St Louis Federal pegged it at minus 0.2%.
As noted, CPI inflation peaked at 9.1% in June. A year earlier the household survey and bond-market conditions were forecasting 4.8% and 2.1%.
Dart boards are better
Jane Smith drives, buys groceries and notes prices for gasoline and bread. But she’s hardly able to weigh the likelihood and consequences of war and terrorism in Europe, the Middle East and Asia, or when droughts, if ever, will abate.
Likely, she’s more influenced by what NPR reports Fed officials are thinking, and Jane and Jerome may be trapped in a hall of mirrors.
All this talk is doing no good.
In the statement released after the Nov. 2 policy making meeting, the Fed said future interest rate increases “will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
Taking that as a sign that the Fed will soon ease back from its pace of tightening, stock prices jumped. A few hours later, Powell disabused such thinking and stock prices plummeted.
Similar episodes of markets failing to correctly interpret Fed communications, such as the market’s steep drop after Powell’s Jackson Hole speech, hardly do anyone good.
On Nov. 10, Cleveland Fed President Mester said she sees risks in the Fed tightening too little. Meanwhile Dallas Fed President Lori Logan was telling reporters “it may soon be appropriate to slow the pace of rate increases.”
No wonder Jane Smith is confused but perhaps no than Fed policy makers are divided.
Energy prices moderate
Most recently, CPI inflation has trended down but much of that has been energy prices, which have been strongly influenced by President Joe Biden running down the Strategic Petroleum Reserve. That must end soon if enough oil is to be kept for a crisis in the Middle East.
Subtracting energy from the CPI, inflation has not abated. It was 6.6% in June and 7.0% in October, and labor markets remain tight.
With supply-side factors beyond monetary policy’s influence contributing so much uncertainty to the inflation outlook, Powell and his colleagues would do well to be more reticent.
They should simply decide and announce they will push up the federal funds rate 0.75% at each policy-making meeting until inflation is at 4% for several months and keep rates elevated until inflation descends convincingly to 2%.
Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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