Tuesday, March 7, 2023

Why does Jerome Powell think 4% inflation is a problem? It wasn't in the '80s.

Given the cross-currents of moderating inflation but a still-strong economy in recent months (especially in the jobs market), let’s see what the Fed Chair had to say on Capitol Hill today.
Federal Reserve Chairman Jerome Powell told lawmakers Tuesday that policymakers may have to speed up their interest rate hikes to tame high inflation.

With prices continuing to rise at a yearly pace of 6.4%, according to government data, Powell warned that it may take time for Americans to see further relief.

“The process of getting inflation back down to 2% has a long way to go and is likely to be bumpy,” Powell told the Senate Banking Committee, referring to the central bank’s target inflation level.

Speaking in the first of his two days of semiannual testimony to Congress on interest-rate policy, Powell said the Fed could again increase the size of its interest rate hikes if it doesn’t see stronger progress on lowering inflation in the months ahead.

Wall Street sure got the message, and the DOW Jones dropped by nearly 575 points. I want to unpack a couple of items out of those four paragraphs.

First of all, NBC reporter Brian Cheung wrongly states that “prices are “continuing to rise at a yearly pace of 6.4%.” Prices have gone up by 6.4% in the last 12 months, but that is wildly split between what happened in early 2022, and later 2022 into January 2023, and inflation is much lower than a 6.4% pace in the last 6 months.

Total increase in inflation, US
Jan 2022 - July 2022 4.3% (8.6% annual rate)
July 2022 - Jan 2023 2.0% (4.0% annual rate)

And February seems likely to have relatively low inflation (especially with gas prices declining that month), and keep us at or below that 4% annual rate of inflation. So why would we have Fed Funds rates continue to go up, and zoom well past 5%?

Second, why is 2% inflation such a magic mark, anyway? In late 1984, Ronald Reagan won big by proclaiming it “morning in America”, with an allegedly booming economy. That “boom” included 12-month inflation being over 4% the entire year, unemployment staying over 7%, and John Mellencamp writing this song about farmers losing their land.

The 12-month increase in America’s median weekly wage for full-time workers was 5.4% in the quarter when it was Morning in America. Which is much less than the 6.9% increase in Q3 2022, or the 7.5% it increased in Q4 2022. And new revisions, overall incomes rose at a 6.5% annual rate between July 2022 and January 2023.

So if early 2023 has Americans seeing their incomes/wages rise by 6-7%, and corporate profits continuing at their record-high levels, what is so worrysome about 3% or even 4% inflation? Especially in a time when the labor market has much less slack and more participation from working-age Americans than it did in 1984.

I’d want to keep that situation going as long as possible, and I sure wouldn’t want to crash housing and asset markets, and increase the chances of layoffs in construction and other interest-rate sensitive sectors. Instead, the Fed's actions have encouraged the 30-year mortgage rate to reach 7% in late 2022 for the first time in 20 years.

And for what? To say “I got inflation down from 4% to 2%!”

Lastly, the brakes are already happening from the fiscal side, especially among lower-income Americans. Expanded SNAP benefits expired last week, and as many as 14 million may be cut off of Medicaid in the coming months, and will have to figure out a way to get themselves and their family insured (IF they figure out a way).

So continuing to hike rates to deal with an inflation that peaked several months ago seems very dumb, especially in a time when the working-age population is a much lower proportion of the work force than it was when Boomers were in their 20s, 30s, and 40s. Why is Jerome Powell thinking that we are in the same circumstance as the 1970s or 1980s, when the situations are very different?

On a related note, why aren’t we telling the truth about how the US economy is an even stronger place than a time when we claimed it was Morning in America with seemingly unlimited growth (and plummeting interest rates) ahead? And that 4% inflation with continued growth will be a whole lot easier to deal with in 2023 than 5% unemployment with growth going away.

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