Cyclicality is part of nature. We humans, and other forms of life, all overreact or overdo things so that restoration of equilibrium and balances is a necessity ensured by nature. The longer the cycle, the more out-of-balance the situation, the greater the force of restoration.
The Fed has been using easy monetary policy for a long time in an attempt to “smooth out” (i.e. avoid) economic cycles. This policy has created and sustained many asset bubbles around the globe. While I agree that Fed should have acted much sooner, it isn’t the cause of the current inflation. Japan, for example, has had much longer period of zero (even negative) interest rate policy without triggering inflation (it only very recently started to experience some inflation because it, unlike the US, has to import all its energy from abroad). The loose fiscal policy is what triggered the current cycle of inflation.
I do wonder whether current fiscal and monetary tools do not address supply shortages.
I feel a bit dense,
How does the Fed raising interest rates help a household address rising fuel and food prices? For many, their demand for fuel and food is fixed.
I think the fiscal policy and geopolitics helped create many of these shortages. Rising interest rates will dampen economic activities and reduce overall demand for all products. The degree of their effects will, of course, be uneven. The prices of energy and food are always the most volatile. If economic activities around the world slow down due to higher interest rates, the cost of energy will come down (the war in Ukraine is likely to continue for some time, unfortunately, so there will be a floor to energy prices). Food is obviously a necessity so it’d be the least affected, but its price should also be stabilized if the costs of transportation and labor are stabilized.
Unfortunately, some basic foodstuffs are also impacted by the war in Ukraine, which is a huge grain exporter to the world. In fact, Ukraine is among the largest producers of wheat and corn If Putin is successful in shutting down those fields, not only will Ukraine suffer economically, but so will the rest of the world with some higher food prices.
There is some level of permanent inflation that will occur because of 1) the U.S. labor force has likely reached its peak size, or is close to it, and that will continue to drive wage growth into the future, and 2) the deficit spending by our government is inflationary. This might result in a normalized inflation rate of 3% or maybe 4%. Not 8 or 10% though.
I don’t know what you mean by a policy designed to maintain high energy prices. There are thousands of unused wells and oil is around $105 or $107 a barrel, which is high, but not stratospheric by any means. Renewable energy is dropping in price and getting more efficient.
The economy is much more efficient than it was in the last inflation shock. Globalization generally suppresses price growth, and with the demand destruction underway right now, I would not be surprised to see deflation in some sectors. Economists grab more attention with outrageous predictions of a return of 18% interest rates like we had in 1980, but the demand destruction is already occurring and will accelerate as rates raise. I think getting rates to 2.5% or 3.0% plus tapering will cool the economy down quite a bit.
Americans consume relatively little grains compared to underdeveloped countries and the contribution of grain prices to inflation is relatively small in this country. Together with Canada, we also produce about half of the world’s grains (Ukrainian production is a tiny fraction in comparison), so the Ukrainian crisis will mostly affect those other countries. However, we use a large fraction of grains we produce to feed livestock, not just in this country but around the world. Higher cost of meat will lead to reduction of meat consumption everywhere, decreasing the demand for grains in this country.
“This might result in a normalized inflation rate of 3% or maybe 4%.”
The Fed’s target is 2%, so the question is how high does the Fed have to move its rate to get inflation down to ~2%.
“I think getting rates to 2.5% or 3.0% plus tapering will cool the economy down quite a bit.”
No question but will it be enuf to get inflation down to teh 2% target? Personally not seeing it. (I hope you are right and I am wrong.)
Hopefully not, but not sure anyone here has indicated otherwise. (Or I missed it if they have.)
btw: the growth in renewables is fantastic, but they will have little affect on the short-term. Plus, that industry faces the same supply-chain problems as every other, if not more, since much is from overseas. Solar installs in my 'hood are being scheduled 9+ months out, at the earliest.
This is a tiny part of the overall picture which needs to include so many other factors. Let’s talk about just one, oil and gas prices. Everything needs to get to the consumer, higher prices for gas affect nearly every physical product. People start to pay more for everything partly due to gas, even knowledge workers then increase their rates. My plumber, up $25/call. The landscaper, up $35/cut and so on.
Everyone and everything is tied into inflationary pressures. A small change in the fed funds rate isn’t going to move an entire economy. Wish it could, but it can’t. Going to get a lot worse before it gets better. Best move would be to produce more oil and gas. That trickles down into almost every segment. Even then inflation isn’t going away.
I have a hybrid plug-in with a 30 mile range on a charge. It doesn’t sound like much but I only drive an average of 10-15 miles a day. DD and DH want EVs and the waitlist is at lease 6 months.
With your fixed rate mortgage, you benefit from inflation effectively reducing the value of the principal you need to pay back. Indeed, if you are paying 3% interest, but inflation is greater than 3%, your are effectively borrowing at a negative real interest rate.
As for energy, are you talking about oil or gas? Oil prices are high, but not off the charts by historical standards. Gas prices, on the other hand, are off the charts. That would seem to indicate a deliberate and coordinated price increase by the oil companies. The Department of Justice has tools to address collusion.
I don’t know that a 2% inflation target is realistic without a balanced budget or a major recession.
There has been a massive asset repricing in the last 6 months. I am not sure what people are talking about when they say nothing has happened. The S&P is down 17% and the NASDAQ is down 27%. These are huge adjustments to all of our net worths. Home prices are trailing, but I am confident that you would have a hard time selling your house for the same price you could have gotten 3 months ago.
This will have a major wealth effect impact on Americans. I would welcome an explanation for why a 17% dip in the S&P and 27% dip in the NASDAQ will have no wealth effect impact on consumers. Please explain.
Huh? 2% is Jerome Powell’s inflation target, so its the Fed that has to do the explaining on how they will get there.
btw: I don’t believe that they can get there without some pain and that a so-called soft-landing is wishful (prayerful?) thinking and that a recession is right around the corner.
But clearly your crystal ball is not as cloudy as mine.
Stock price drops will directly affect the wealth of 58% of Americans who own stock, but the degree it does differs for each person or household. But note that if they are following typical investment advice to invest in stocks only money not needed immediately, drops of fluctuations may not be big factors in consumer spending habits.
Also, stock ownership is highly concentrated. The following suggest that the top 10% of net worth own the vast majority of stocks and pooled investment funds:
So the effect of the stock price drops for most people and households may be small in absolute amount. (It also means that most people and households did not gain that much from the stock price rises before.)
Stocks are also held by pension funds. The drop in their value impacts the health of those pension funds. If the value drops beyond a certain threshold, the company providing the pension will be required to make up the difference, directly impacting the income and balance sheet of that company.
Such an effect will take some time to happen, rather than happening now. Also, how many non government employees have defined benefit pension plans these days?
I do, but a very small amount, in fact the two jobs I had before I retired provide a tiny pension. Enough for me to buy flowers without worrying about anything.
There are very few pensions available to new employees. But there is about $20 trillion invested in pension plans, of which about 60% was in stocks at the end of 2021. The sheer size means it impacts tens of millions of people.
And given that it effects literally millions of public employee pension plans it will impact local states and municipalities who will have to adjust their budgets to fund these plans. As a result either services will have to be lessened and or taxes raised. In practical terms everyone across the country is impacted.
Along with endowments, pensions, unlike their counterparts in defined contribution plans (such as 401k), invest significant portions of their assets in the alternative investment space (e.g. HF, VC), so that much of their exposure to the equity market may be indirect. Many of them are also likely to have significant investments in commodities, which are generally doing very well (assuming they hold net long positions) in the current inflationary environment. I suspect their performances may not be as highly correlated with the stock market as we may assume.
