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On November 22, the President of the United States Joe Biden nominates Jay Powell againl As the chairman of the Federal Reserve. Eight days later, Powell told Congress that “it might be a good time to drop the word and try to explain more clearly what we mean.”The magic word for his upcoming retirement is “temporary”. This mantra allowed the Fed to stick to an extremely expansionary monetary policy during the strong recovery that accompanied inflation soaring. The cynic might argue that the term’s retirement timing isn’t just accidental. I can’t comment. On the contrary, let’s hope this transition is not too late.
In 1955, Chairman William McChesney Martin The Fed was “in the position of a partner, ordering the removal of the blackjack when the party really warmed up,” the comment said. This is sound advice, as evidenced by the currency turmoil some two decades later. Losing control of inflation is harmful both politically and economically: regaining control often requires a deep recession. However, the Fed has been taking that risk lately, as it hasn’t even begun removing a punch bowl with a high alcohol content.
Whether or not inflation is indeed temporary does not depend primarily on market conditions for a particular product. It depends more on the environment in which the shock occurs. The risk is that in a highly supportive policy environment like today’s, price shocks could easily ripple through the economy as workers and other producers struggle to make up for losses.
So we have to start with the state of the economy. The Institute of International Finance noted that real U.S. consumption has now fully recovered to pre-pandemic trends. This never happened after the 2008 financial crisis. Commercial and residential investment was also very strong. The recovery has been stronger than in other large high-income countries. The IIF believes that the main reason for this rude health is fiscal stimulus. (See chart.)
The labor market has also recovered substantially, and by some measures, the labor market is hot.in a The latest from the Peterson Institute for International Economics, Jason Furman and Wilson Powell show that the prime-age nonemployment rate, unemployment rate, unemployment per job opening, and resignation rate are all stronger than the 2001-2018 average. The last two are at record levels.As Jay Powell himself said At a press conference last week, “Labour market conditions are consistent with the maximum employment level, that is, the maximum employment level consistent with price stability”. In other words, the Fed has done its job.
The strong labor market is also reflected in rapid growth in nominal incomes, with clerical workers receiving higher total compensation than pre-pandemic trends. However, actual compensation in December 2021 was 3.6% below trend. This is because annual consumer price inflation hits 7%, Highest rate in four decades. Even core inflation (excluding volatile items like energy and food) hit 5.5%. Furthermore, contrary to the belief that it is only a few factors involved, the IIF shows that inflation is above 2% in a weighted index of more than 70%.This price increase is a phenomenon without limitations.
Prices for the scarcest items will rise more slowly, and many will even fall. But that’s not enough. One reason is that affected businesses and workers will seek to cover losses, risking an inflationary spiral. Another reason is that policy remains very accommodative given continued asset purchases and the 0.25% federal funds rate. Regardless of supply disruptions, the central bank still needs to adjust policy according to demand. However, even as the party is turning into a rave, the Fed continues to flex its muscles.
Furthermore, given the “long and variable lag” in the relationship between monetary policy, the economy and inflation, Described by Milton Friedman, it’s hard to believe that the Fed is getting close to where it needs to be today. The Fed itself agrees: Tightening is on the way. But the question is whether it can still contain an inflationary spiral and keep expectations stable without causing a recession. This will be very difficult to achieve.Policymakers don’t know enough about the post-pandemic economy to adjust the policy changes needed, especially now that they Apparently it’s too late.
under these circumstances, The Fed Board’s December forecasts are confusing. The median view is that core consumer price inflation will fall to 2.7% this year and 2.3% in 2023, with unemployment stabilizing at 3.5%. Meanwhile, the federal funds rate is expected to be between 0.6% and 0.9% this year, and between 1.4% and 1.9% in 2023 (if we ignore the top and bottom three).We must note that these forecasts are lower than the Fed’s own Neutral interest rate, i.e. 2.5%. Furthermore, the assumed real interest rate is also negative. Perhaps board members believe that aggressive asset sales will deliver the needed tightening through higher long-term interest rates. Or, they must believe that even if monetary policy remains expansionary, the economy and inflation will be smooth and stable.
It will be perfectly stable. As you can imagine, the policy settings chosen at the height of the Covid-19 crisis still make sense today. It is also conceivable that the predicted contraction will lead to strong growth and smooth deflation. Both are less likely than the moon to be made of green cheese. But is it possible? Not so much.
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