American politicians had tried to control inflation before. The presidents and power brokers of the 1970s had tried price controls, public campaigns, pressure programs, blame games, and attempts to redefine basic economic terminology. The parties differed on the specifics, but both seemed to agree that the voting public and the private sector were to blame, not the bureaucrats and politicians in charge.
Inflation, in short, was a political problem, in the sense that it caused problems for politicians. But it wasn’t one America’s politicians knew how to solve.
On the contrary, America’s political class had spent the ’70s failing to fix inflation, or actively making it worse, often with policies designed to address other political and economic problems. That decade’s price hikes were prolonged and exacerbated by political decisions born of short-term thinking, outright cowardice, and technocratic hubris about policy makers’ ability to enact sweeping changes and manage the macroeconomy.
To understand how interest rates influence inflation, we need to understand how inflation works. Inflation is the result of too much money chasing too few goods. Over the last several months, this has occurred amid a surge in demand and supply chain disruptions worsened by Russia’s invasion of Ukraine.
In an effort to combat inflation, central banks will raise their policy rate. This is the rate they charge commercial banks for loans or pay commercial banks for deposits. Commercial banks pass on a portion of these higher rates to their customers, which reduces the purchasing power of businesses and consumers. For example, it becomes more expensive to borrow money for a house or car.
Ultimately, interest rate hikes act to slow spending and encourage saving. This motivates companies to increase prices at a slower rate, or lower prices, to stimulate demand.
Ark Invest founder and CEO Cathie Wood is drawing snarky comments on and off Twitter after posting an open letter to the Federal Reserve challenging the central bank’s aggressive interest-rate hikes.
Wood published the letter on her firm’s website Monday as her ARK Innovation ETF (ARKK) sustained more blows in a year that has seen its returns slide more than 60%. Bloomberg reported Tuesday that the fund, which has fallen more than double the S&P 500′s decline, was down about 11% over three days.
Wood voiced concern the Fed is making a policy error that will lead to deflation and said it seemed to be basing its decisions on two lagging indicators: employment and headline inflation from official reports such as the Consumer Price Index. These variables “have been sending conflicting signals and should be calling into question the Fed’s unanimous call for higher interest rates,” she wrote.
The Wharton professor Jeremy Siegel has a big issue with the Federal Reserve’s aggressive interest-rate hikes in its bid to tame inflation, and he’s worried that the central bank is making the biggest mistake in its history and may provoke a steep recession.
Siegel said inflation is starting to come down significantly, but the Fed is still moving forward with its rate hikes.
He said it could be “one of the biggest policy mistakes in the 110-year history of the Fed, by staying so easy when everything was booming.”
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“I think the Fed is just way too tight. They’re making exactly the same mistake on the other side that they made a year ago,” Siegel added.
To Siegel’s point, the Fed has had a lousy record of accurately forecasting where it expects interest rates to be just a few months into the future.
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“I am very upset. It’s like a pendulum. They were way too easy through 2020 and 2021, and now ‘we’re going to be real tough guys until we crush the economy,'” Siegel said of the Fed.
Siegel expects the Fed to “eventually see the light” as none of their recent predictions are likely to come true.
The Fed participants have a median expectation of 4.25 to 4.50 percent for the end of 2022
That’s another 1.25 percentage points more this year.
The Fed then anticipates one more hike in 2023 to 4.50 to 4.75 percent.
I have to admit that a year ago I did not foresee this. But here we are.
The key question is not where we’ve been but where we are headed. I Highly doubt the Fed hikes another 1.25 percentage points this year or gets anywhere close to 4.50 to 4.75 percent in 2023.
The curve has been inverted in places for over a year. This is a recession signal and I believe the economy went into recession in May.
The Fed is merrily hiking away and is likely to keep doing so until it breaks something big time. The Fed will hike 75 basis points tomorrow and the market thinks another 75 basis points is coming in November.
If so, it is doubtful the markets will like it much.
After another dismal U.S. inflation report, economists at the brokerage Nomura Securities on Tuesday became the first on Wall Street DJIA, 0.12% to predict a full-percentage-point increase in the Fed’s benchmark short-term rate.
“We continue to believe markets underappreciate just how entrenched U.S. inflation has become and the magnitude of response that will likely be required from the Fed to dislodge it,” the economists at Nomura wrote in a report to clients.
The last time the Fed made such a drastic move was in the early 1980s — another period marked by sky-high inflation.
At each of the last two meetings, the monetary-policy-setting Federal Open Market Committee raised the targeted rate by 0.75 point.
We simulate future realizations of the policy gap and the slope of inflation forecasts from the 2022:Q2 initial conditions through 2023:Q4 using the ABC model. We then evaluate the recession probability predicted by our preferred probit model for each of these simulated paths. Through this analysis, we show that future inflation outcomes and the odds of a recession depend critically on both the pace of removal of monetary policy accommodation and on how restrictive the monetary policy stance will become over the medium term. In particular, we highlight two scenarios: The first one, which we refer to as the “baseline case,” reflects the ABC model forecasts or, equivalently, the average of all simulated paths. The second one, which we label the “tighter-policy scenario,” is characterized by a faster removal of monetary policy accommodation; it is identified by the average of the simulated paths in which policy becomes restrictive by the end of 2022.11
1. Baseline case: As of early June 2022, the ABC model predicts that nominal and real yields will rise over the next six quarters, the current policy gap will narrow and become mildly restrictive in mid-2023, while core inflation will fall and remain around one percentage point above its model-implied longer-run expectations through 2023 (figure 2, blue lines in panels A and B). The expected tightening of the policy gap and a downward-sloping expected inflation path combine to increase the one-year-ahead recession probability to about 35% by 2023 (figure 2, blue line panel C). Such a level is comparable to the one estimated ahead of the 1994 monetary policy tightening cycle that was followed by a soft-landing scenario.
2. Tighter-policy scenario: In this alternative scenario, monetary policy becomes more restrictive than in the baseline case, in that the policy gap is markedly restrictive over 2023. In this case we find that core inflation declines more rapidly than under the baseline, closing the gap with its model-implied longer-run expectations almost completely by the end of 2023. By that date, in this scenario the likelihood of a recession approaches 60%, a level that, based on our historical estimates, is generally followed by a recession in our sample (figure 2, red lines).
Author(s): Andrea Ajello , Luca Benzoni , Makena Schwinn , Yannick Timmer , Francisco Vazquez-Grande
Yesterday, the market penciled in a three-quarter point hike. Today, the market expectation is for a full point hike.
The WSJ notes that would be the largest hike since the Fed started directly using overnight interest rates to conduct monetary policy in the early 1990s.
Common sense and practical examples suggest that inflation expectations theory is ass backward.
So much of the CPI is nondiscretionary that it’s difficult to impossible for CPI expectations to matter.
Yet, economists focus on expectations that don’t matter and ignore the expectations that do matter, namely asset prices!
I have written about this several times previously, two of them before I even found the Fed study supporting my view.
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A BIS study concluded “Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive.“
Indeed, that must be the case as more goods for less money by default improves standards of living.
The Fed was hell bent on reducing standards of living via inflation. Now they struggle to undo the inflation and asset bubble consequences they created.
Monetary inflation occurs when the U.S. money supply increases over time. This represents both physical and digital money circulating in the economy including cash, checking accounts, and money market mutual funds.
The U.S. central bank typically influences the money supply by printing money, buying bonds, or changing bank reserve requirements. The central bank controls the money supply in order to boost the economy or tame inflation and keep prices stable.
Between 2020-2021, the money supply increased roughly 25%—a historic record—in response to the COVID-19 crisis. Since then, the Federal Reserve began tapering its bond purchases as the economy showed signs of strength.
