Federal Reserve Chairman Jerome Powell, through the FOMC statement and press conference remarks last week made clear we’ve made progress fighting inflation but it’s far too early to quit.
Financial markets are proving skeptical—forward contracts anticipate the Fed will increase interest rates a bit further then start cutting the latter half of this year.
Powell should stick to his guns.
Inflation, once ignited, metastasizes through the economy unevenly. Progress in some sectors and setbacks in others gauged by a few months’ data can be deceptive and complicate monetary policy making.
In early 2021, generous stimulus checks that swelled the Fed balance sheet and money supply, work-from-home that shifted demand to goods from services, chip shortages and logjams in global transportations accelerated inflation.
By May 2021, household expectations for inflation a year forward as tracked by the Conference Board, New York Federal Reserve and University of Michigan averaged about 5%.
As importantly, the lines crossed in the labor market—job openings began exceeding the number of Americans looking for work.
Fiddling while inflation burned
Powell minimized these developments. He flirted with notions that printing money had few consequences for inflation and full employment was a long way off. He delayed raising interest rates until March 2022.
Bad advice likely helped.
Macroeconomists appear enamored with the idea that observing financial market conditions can reveal the mysteries of the universe. They look to the differences between the interest rates paid on ordinary and inflation-indexed Treasurys to get a fix on where economic actors believe inflation is going.
Throughout 2021 the one-year spread never exceeded 2.7% but in 2022, inflation turned out to be 8%—closer to what consumer surveys predicted.
Powell and Treasury Secretary Janet Yellen would have been better informed had they fired their economists, been given a list of the 25 most frequently purchased goods and services and went shopping every month at Trader Joe’s, Lowe’s and HomeAdvisor.
Going forward, a lot of latent inflation threatens.
Last year, falling U.S. gasoline prices were helped by President Joe Biden drawing down the Strategic Petroleum Reserve—that’s hardly a sustainable long-term strategy.
Gasoline prices moved up in January and that will boost the next round of consumer price reports.
We haven’t yet seen the full impact of Western sanctions on Russian oil and gas exports. This year, U.S. LNG exports to Europe should rise, threatening further pressure on U.S. utility prices.
China’s reawakening will instigate stronger growth, potentially raising global inflation a full percentage point.
Grain exports from Ukraine are not likely to increase, and climate change is wreaking havoc on farmers around the world.
Year-over-year U.S. farm prices were up 22% in December, and those will filter into grocery prices moving through 2023.
The labor market remains tight. Workers jettisoned by tech giants like Meta and Twitter are finding new positions elsewhere in the tech sector and in the finance, healthcare and retail industries.
Job openings exceed job seekers by nearly double. Small businesses continue to hire, and the labor market is hardly in balance.
The recent employment report, despite a breathtaking gain in jobs created, showed some easing of wage pressures but with so much hiring still going on it’s tough to bank on wage pressures easing.
Wages are pressuring inflation readings in the core services Powell closely watches.
Investing in green energy is pushing up the cost of electricity and automobiles. The grid is terribly overtaxed, and utilities lack good alternatives to natural gas when cold weather slows windmills and storms reduce solar output.
From 2013 to 2021, the cost of purchasing lithium-ion battery packs fell about 80% but now that trend is reversing. Engineering improvements are getting tougher to accomplish and tight material supplies abound.
Car makers will unveil new electric vehicles in the coming months, but those will be expensive. Some chip and other part shortages will continue for auto makers. Car prices will fall but only to the extent a slowing economy and high interest rates would make consumers reluctant to buy.
Rents on new apartment leases are falling, because new household formation has dropped. That will take the housing component of the consumer price index south later this year, but rents will rise again as the economy strengthens in 2024 and more young people establish residences.
Higher interest rates needed
Powell would do well to keep pushing up interest rates a quarter point for a few more meetings and then keep those elevated until inflation is at or below 2% for at least six months.
Recent strong jobs report notwithstanding, that could give us a recession. But harsh memories of the 1970s when the Fed failed to stay the course indicate a period of higher unemployment is the price we may still have to pay for overly aggressive COVID-relief spending and printing too much money in recent years.
Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.