prices for just about everything
are rising fast. And October 2021. Inflation took its biggest
jump in more than 30 years. It's hitting specific parts of the
economy hardest. drivers face a 59% increase in the pump
compared to one year ago. The average US vehicle is selling
for 26% more than it was a year ago. vacation homes are renting
out a premium to nobody likes to play. Nobody
wants to pay higher prices for anything really maintaining stable prices is one
of the Federal Reserve's main responsibilities. In recent
decades. The economy is home below the central bank's target
rate. Now post pandemic, the Fed they
want inflation at least for a while to be above 2%. And
they'll get exactly what they want simply because of the
acceleration rent growth. Critics say there are signs of
turmoil in the economy that the Fed isn't hearing. I think it's pretty darn clear
that the Fed cannot control inflation on the downside or the
upside. Given the current experience central bank has its defenders
to the weight of the evidence is
finally going pals way teen transitory is going to win.
There's a lot of reasons to think that
inflation is transitory. It doesn't mean it's going to be
two months it could be a year, but it's not going to be four or
5% a year for the next five years. In the backdrop, governments are
spending big to keep society afloat. The US Treasuries debt
is managed by the Fed, the bank's assets swelled as it
printed trillions of dollars to backstop the country. Which
leads to the question, can the federal reserve control
inflation? And if so, what could it do to rein in the cost of
living in the United States the people who manage the US economy
prefer to keep inflation around 2%. That's because a low and
steady rate produces a healthy business environment. These
rates are tracked in categories like food, energy and housing.
These components are then weighted against one another to
establish their importance. The final scores that are produced
are then recorded over time. The primary one you hear about on
the news is called the consumer price index. It tracks all of
the spending from 93% of the US population. Then there's the
trimmed mean inflation, which throws out outlier data and
focuses on core prices. movements in the trimmed mean
signal a more potent inflationary trend, then there's
the PCE, the Fed really prefers to look at PCE that is personal
consumption expenditures Price Index, the Feds preferred measure of
inflation is broader than the trimmed mean, but it throws out
some data from the energy and food sectors. That's because
prices take bigger swings in these industries more
frequently, what's included and what's excluded from each
inflation index impacts its reliability. Some like Danielle
DiMartino booth, a former Dallas Fed employee believe that the
PCE is flawed. My biggest issue with the PCE is that for
your average American household, you spend between 40 and 50% of
your income on housing. If you look at it through that simple
of a prison and understand that the PCs input for housing is
only around 22% Then you see that you're under accounting
households biggest expense by a wide margin. In the fall of 2021, the PCE
numbers spiked to generational highs. When events like that
happen, public officials turn to the Fed for answers. The Federal
Reserve was originally set up to create a stable American banking
system. Its role has expanded over its century long existence
in 1977. Congress gave it a dual mandate. Part of that mandate is to
maximize employment. The other part of that mandate is to
stabilize prices or to basically keep inflation in check. Wilson says that the feds
ability to manage inflation depends on the extent to which
inflation is driven by the labor market. We're currently seeing inflationary pressures,
largely because people have shifted their consumption from
purchase of services the purchase of goods that has
caused demand for goods that outpaced the supply of goods,
you know, a period of time that suppliers did not have adequate
time to really respond to that increased demand. In 2021, a sputtering global
supply chain and backed up ports are causing delays. Many people,
including the leaders of the Fed, don't believe the economy
has settled. Chair Powell previously said this bout of
inflation is transitory. But now he's walking back from using
that language, we tend to use it to mean that it
won't leave a permanent mark in the form of higher inflation. I
think it's it's probably a good time to retire that that word
and try to explain more clearly what we mean. The central bank believes
current conditions don't change the long term outlook. That's
because in recent years, inflation has actually been
lower than what the Fed wanted pre pandemic inflation was a
soft Fed Reserve at a 2% inflation target. It was below
2%. Now post pandemic the Fed has been saying they changed
their their thinking here they want in At least for a while to
be above 2%. And they'll get exactly what they want simply
because of the acceleration and rent growth. In 2019. Newly elected chair
Powell argued that long term expectations of inflation were
low. Experts observing the labor market reported that the
interest rate lift off that began in 2019, cut the recovery
short, then an unexpected event, the pandemic pushed the central
bank to create accommodative financial conditions. That means
dropping interest rates, which in theory will make prices rise
more quickly. Nobody likes inflation. Nobody
wants to pay higher prices for anything really, economists believe that
expectations are the primary driver of inflation. When people think inflation is
going to be high for a long time, they're gonna say, Hey,
Mr. employer, you got to pay me a bigger gotta give me a bigger
pay increase because inflation is going to be high. And the
businessman says if he thinks that he or she thinks inflation
is going to be high, as they find no problem, I'll give you
the bigger pay increase, but and then I'll pass along the higher
price increase to consumers. And then lo and behold, people's
expectations, their views of the future inflation actually
results in higher inflation. That's the problem. A wage raise means a
corresponding rise in prices, unless productivity is increased
proportionately. What do you want a guy with forearms. But even people within the Fed
think these models are broken. In September 2021, a senior
economist at the Board of Governors published a paper it
was titled, Why do we think that inflation expectations mattered
for inflation? That's definitely a non
consensus view. The paper argues that the field
of mainstream economics provides cover for a quote, criminally
oppressive, unsustainable, and unjust social order. The paper
reflects the views of a wider movement of people who think the
Fed needs reform. There was an internal debate
inside the Fed in 2008, in 2009, in 2010, why did we miss the
financial crisis? Why did we miss the subprime crisis, and it
was determined at the time that the feds inflation model really
was broken, because had it incorporated securities prices
had it improperly incorporated that the price of housing
residential real estate, then the Fed wouldn't have been
blindsided ahead of the financial crisis. So what they
did after writing all these internal white papers and
determining that they needed a new inflation regime was
nothing. And because they needed this broken model to hide
behind, which systematically understates inflation, so that
they could keep easier monetary policy than they would otherwise
to prop up the stock market. Many people who watched the Fed
cite breakdowns in models like the Phillips Curve. The Phillips
Curve is a model that economists use to make interest rate
decisions. The model contains two inputs, inflation rates, and
employment data, various forces shift where the economy is along
the curve at any point. When the employment indicators point to a
tight labor market, the plot of the Phillips curve shifts to the
left. That means that there are more jobs open than there are
workers to fill the roles. That also increases the pressure on
employers to raise wages, which means higher rates of inflation.
The Fed can control inflation, when it's coming from the labor
market. Their main tool for doing that
is the federal funds rate. And by lowering that rate, it tends
to help to spur economic growth and job creation. And when they
raise that rate, it tends to slow that growth and the
resulting job creation. The reason for doing that would be
if there were concerns about inflation going too fast or
potentially getting out of control, because the
unemployment rate is too low, and starting to put upward
pressure on prices. Because there is upward pressure on. Some economists believe that in
2019, the official models produced an error that year,
unemployment dropped to 3.5%. When unemployment gets this low,
the Phillips curve tells us that prices should start to rise. The
Fed started to hike interest rates before sending them back
down in the pandemic. I think one of the things that
we have learned coming out of that recession and more recently
is that the economy has probably been further from what would be
a genuine level of full employment. Some say that the failure to
lift off interest rates is a mistake that the country will
have to pay for in the future. Jay Powell in 2018 2019, found
out that he couldn't raise interest rates so he failed to
get interest rates to his his own personal state at targeted
3%. He never got to when you have a federal reserve that one
cycle after another. They try to resolve An underlying issue of
over indebtedness, whether it was the household sector before
the financial crisis, or the corporate sector before Covid
hit, every time they have a crisis hit, they try and solve
the problem of over indebtedness. By putting more
debt into the economy. Others still believe that the country is in
an extraordinary time that calls for emergency measures, the current environment that we
find ourselves in is extremely unusual. All of that really is
affecting inflation in a way that we wouldn't typically see,
during the normal course of how the economy functions. In recent decades, outside
forces changed labor in fundamental ways, when unions were a force to be
reckoned with. And when employees had the upper hand,
then there was a very tight relationship between inflation
and wage inflation. So you can have this spiral of rising wages
when we started to de unionize the country, when employers
started to outsource to India and other countries and started
exporting deflation, because its labor was so much cheaper. All
of these elements ended up giving employers, the upper hand
over employees in America. So the efficacy of the Phillips
Curve started to become kind of outmoded. And there wasn't this
immediate feedback effect from rising prices into rising wages, policy decisions, informed by
models, like the Phillips Curve have had a real impact on
American workers. The wages and benefits of a
typical worker were suppressed in that period for decades after
1979. Why is that? Well, it's not because the economy was
doing poorly or because of automation, or because of low
productivity growth. In fact, it was because of policies, which
generated a situation where wages were suppressed excessive
unemployment because of failed macroeconomic policy, monetary
and fiscal policy to the bashing of unions to decline in union
membership, that failure to increase the minimum wage and
along with inflation, various new policies of corporations,
forcing people to sign non competes and forced arbitration
agreements. As a result, leaders are making
adjustments to prepare for the new normal and longer term inflation expectations, which we
have long seen as an important driver of actual inflation. And
global disinflationary pressures, may have been holding
down inflation more than was generally anticipated president by nominated Powell
for a second term, hoping that would help the Fed maintain its
independence by nominating Jerome Powell. That'll be
important, as the group embarks on a new and unusual decade. So I think the strategy that the
Fed is now pursuing is the stated stated strategy is to try
to keep the job market really tight, really strong, you know,
for an extended period. And that means then you'll see stronger
wage gains across all income groups, but particularly low
wages. But it's, it's a tricky thing, and you know, very
difficult to pull off, the Fed has kept interest rates
near zero for more than a decade. And the outlook suggests
that it will keep rates low for the foreseeable future. That's
because the United States and countries around the world have
failed to hit their inflation targets. In recent years, the Fed itself was incapable
before of creating inflation. It was quote, unquote, pushing on a
string. So it said, you know, we're going to allow inflation
to run hot going forward, so that we can try and, and balance
out all of these years of not being able to produce the
inflation that we said we wanted to target a being underneath
that 2% target for so many years. In other words, if the temporary
bottlenecks caused by the pandemic and its supply chain
disruptions fade, will need to keep interest rates low to keep
the economy afloat. Some say the Fed may be better off pursuing a
higher long term inflation target, possibly of 3% that can
fight the expectations of sluggish future growth. I think that deflationary forces
will continue to be a force, especially up the income ladder,
now that you can put an entire law library into a little chip
of big data. You don't need a paralegal in the United States,
you can get a paralegal in India. So higher income paying
jobs right now are the ones that are at risk of being sent over
shores and nobody's talking about that you're actually going
to have inflation in terms of the amount of education you need
in America, you're going to need that graduate degree to have the
pure certainty of income security going forward, because
you're going to need that next skills level up, because a lot
of jobs that require a bachelor's degree are going to
go away. So that disinflationary impulse is going to be there. But in the short term, the Fed
and the entire country, we'll wait to see if these price
spikes calm. There's no obvious direct way the Fed can
help. Really, the onus I think, is on Congress and
administration lawmakers do have the tools the ability I don't think that the American rescue
plan created this crisis or that the Fed's monetary policy has
created the inflation problem, their ability to change. The
interest rate would do something it would slow the pace of the
recovery
