The Fed has to wait a little longer to raise the rate

Of

Joseph E. Stiglitz and Dean Baker

The US Federal Reserve Board (FED) will meet again on September 20 and 21, and while most analysts expect another major interest rate hike, there are good reasons to pause the sharp monetary policy adjustment. by the Fed. carry out. The hikes applied so far have slowed the economy (the most obvious example is the real estate sector), but its impact on inflation is much more uncertain..

Typically, the effect of monetary policy on the economy occurs with long and variable lags, especially in times of turbulence. Given the depth of geopolitical, financial and economic uncertainty (and in particular regarding the future trajectory of inflation), the most prudent thing is that the Fed suspends the hikes and wait until a more reliable assessment of the situation is possible.

There are several reasons for a break. The first is basically that inflation is already showing a sharp slowdown. The growth of the consumer price index (CPI, the most important indicator for households) was nil in July, and is likely to have been nil or even negative in August. Meanwhile, the Personal Consumption Expenditure Price Index (another widely used indicator that is based on GDP accounts) fell by 0.1% in July.

Some may want to attribute this apparent victory over inflation to tightening monetary policy. But that topic make the mistake post hoc ergo propter hoc (assuming that since A happened before B, then A must be the cause of B) and it confuses correlation with causality. Furthermore, the main drivers of the current inflation trend have little to do with curbing demand. Supply constraints have caused inflation to rise and supply-side factors explain the current decline.

It is true that many economists (including some at the Fed) believed that the supply disruptions due to the Russian war in Ukraine and the pandemic would be over in no time. It turned out that they were wrong, but only in relation to how quickly conditions would normalize. This mistake is largely understandable. Who would have thought that America’s fabled market economy could lack so much resilience? Who would have predicted that it would suffer from critical shortages of baby food, feminine hygiene products and auto parts? Are we talking about the United States or the Soviet Union in its final days?

Also, before Russian President Vladimir Putin began amassing troops on the Ukrainian border last year, no one could have predicted that there would be a great land war in Europe. And now no one can predict how long it will last, or how long it will take the political leadership to stop the ensuing price increases (which in some cases are just the result of the speculative exploitation of war).

But basically, what’s happening with inflation is very simple: many of the supply factors which caused the rise in prices at the beginning of the recovery are now reversed. In particular, the price of gasoline according to the CPI fell by 7.7% in July, and there are private indices suggesting a comparable decline in August. Again, this reversal of the price path was predictable and predictable; the only uncertainty was when it would happen.

Other prices follow a similar pattern. In July, the core CPI (excluding energy and food) had a fairly modest increase of 0.3% and the personal consumption expenditure ratio excluding energy and food increased by only 0.1%. This suggests a relief from delays in importing goods (the problem behind the empty shelves and the disruption that companies suffered during the initial phase of the pandemic).

There is recent data to support this inference. The global supply chain pressure index calculated by the Federal Reserve Bank of New York dropped dramatically from a peak late last year to just above the pre-pandemic level. The Shipping costs are still well above pre-pandemic levels, but have dropped nearly 50% from last year’s highs, and they are likely to continue to decline. The prices of numerous commodities that saw a sharp rise during the pandemic and in the first months of the Russian war have fallen to pre-pandemic levels. For example, the Baltic ‘dry index’ is below the 2019 average.

The automotive industry has also overcome the problems created by the global shortage of semiconductors; According to the Fed’s Industrial Production Index, car production in July was even higher than the pre-pandemic level.

After a year of bad news about inflation and the supply factors that caused it, the good news is now starting to arrive. And while it would not occur to anyone to say that monetary policy should be based on just two months of data, it should be noted that inflation expectations have also moderated: both the University of Michigan Consumer Sentiment Index and the The New York Fed’s consumer expectations survey began showing a decline in inflation expectations in July.

The usual justification for Fed policy tightening is this necessary to avoid a self-fulfilling cycle, where expectations of higher inflation on the part of workers and firms are carried over into the determination of prices and wages. But this cannot happen when inflation expectations are falling, as they are now.

Some analysts have suggested that the US needs a longer period of higher unemployment to bring inflation back to the Fed’s target. But their arguments are based on standard Phillips curve models and current inflation is not consistent with the Phillips curve (which assumes a simple inverse relationship between inflation and unemployment). After all, last year’s surge in inflation was not due to a sudden sharp drop in unemployment, and the recent slowdown in wage and price growth is not attributable to high unemployment.

In light of the most recent data, it would be irresponsible for the Fed to cause a deliberate rise in unemployment, driven by the blind faith that the Phillips curve is still applicable. Policy making always takes place under conditions of uncertainty, and this is particularly important today. At a time when inflation and inflation expectations are already moderating, the Fed needs to pay more attention to the risk of continuing to tighten: in particular, the risk of plunging the battered US economy into recession. . This should be reason enough for the Fed to take a break this month.

Translation: Stefano Flamini

Copyright: Syndicate of the project