Jon
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Joined: 13 Apr 2005
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| How is Fed doing in its fight against inflation |
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The Fed remains on inflation watch, worrying that inflation could take off. Of course, the Fed is on inflation watch all of the time; half of its mandate is price stability, so it has to be watching inflation and potential deflation. Part of the job description.
Two years ago the Fed began raising the Fed Funds rate from 1.0%, the level it pushed it too after the start of the recession, 9-11, etc. It kept the FFR at that level for a over a year in its attempts to get the economy back on track. It took some tax incentives to finally do the trick, but even after the economy started to run the Fed left rates low. Just now rates are at 4.5% with expectations of 5% before the Fed is through.
So with the Fed seeing the need to raise rates 450 basis points and 50 more expected, you would expect to see the inflation curve running higher and the Fed needing to step in and body block it with these rate hikes.
You might expect that but you would not see that. The inflation rate has basically remained the same from the time rates were at 1% to now with rates at 4.5%, i.e. running around 2% (core) year over year. You could argue that thanks to the Fed’s actions inflation has remained in the comfort zone. Of course, we have not seen any real inflation, just the Fed seeing its shadow and fretting that it could be just around the corner. Remember, there was no inflation at all in 1999 and 2000, at least not anything considered to be real inflation, yet the Fed committed economic hari kari, raising rates repeatedly and ending with a 50 BP zinger that was the head shot that killed the expansion. Oh yes, the yield curve was inverted then and Greenspan, a.k.a. Alfred E. Newman, said ‘what, me worry?’
Of course we all paid the price for that inflation snipe hunt. Right now the Fed is also chasing inflation that is no higher than it was back when it started. It is still looking for indications of inflation though inflation remains, as it has for several years now, within the ‘comfort range.’ That makes one wonder if the Fed’s interest rate moves are all just show and no substance. In 2000 it was not so much the rate hikes but the draconian shrinking of the money supply that killed the economy. Right now money supply is overall solid, the Fed leaving it relatively alone. To us that means the rate hikes, while detrimental to the economy, are not as severe as in 2000. That does not mean the Fed is not going to go too far; enough rate hikes will do that buy themselves. The economy is showing signs it needs some relief from the Fed, i.e. a cessation of hikes, so it can weather the current slowdown in the cycle. If it doesn’t get it, the Fed could push it too far and pop it.
We don’t want to make the case that the Fed can continue its rate hikes. Quite the opposite. The Fed is taking action because oil prices are high and housing prices are high, equating that with inflation. Inflation is monetary, too much money chasing too few goods. There are plenty of houses being built to satisfy demand in most instances. Energy costs more but it is not extra money in the system causing it to rise; it is global economic recovery. Prices can rise and not be inflation. The Fed often makes this mistake and takes too much corrective action and ends up choking off a healthy, non-inflationary economy. Right now the Fed has gone far enough with the indications of a slowing economy. Indeed, the Fed could stop right now and go away for good and the inflation rate would not vary too much.
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