And really, what should the target inflation rate be?
Kevin Hassett was correct (and early) to forecast that “transitory” inflation would go higher than Americans were being told, and that it would be far from transitory.
Inflation is now significantly below its recent peak, but Hassett has been arguing that it is too soon to declare victory.
In the course of an article he wrote for Capital Matters in late July, he had this to say:
The big story is that the interest-sensitive sectors have not really responded the way they have in the past to Federal Reserve tightening. As for the top-line number, there is one other factor that has worked against the Fed’s attempt to bring growth down: surging government spending. Over the past four quarters, government spending has added almost 0.7 percent to growth each quarter. Congress is pushing, while the Fed is pulling.
Looking forward, the Fed will have to raise rates until growth gets well below 2 percent. The excess Covid savings are about exhausted, so downside pressure on consumption can be expected. But the onshoring of business investment and the front-loading to take advantage of the expiring expensing rules will likely continue to be major factors in the second half of the year, as will the steady contribution of government spending. We are in a very strange time, when major recession indicators such as the yield curve and the index of leading indicators are blaring recession, but special circumstances are keeping variables elevated compared with where they would normally be in a tightening cycle. Don’t be surprised when the federal funds rate hits 6 percent.
The Fed itself, or at least Chairman Powell, seems a little uneasy.
Dan Irvine, writing in Forbes:
Federal Reserve Chair Jerome Powell shared his apprehensions about persistently high inflation rates in a rather vague speech from Jackson Hole Economic Symposium, leaving the audience and investors to speculate about future policy decisions. The economic landscape today echoes the inflationary upswing of the 1970s, raising concerns about a possible worldwide re-acceleration of inflation.
In the face of stubbornly high inflation, the Fed has been making determined efforts to bring inflation down to its 2% goal. Powell’s recent remarks highlighted the institution’s commitment to this mission, insinuating future policy tightening.
In his speech, Powell firmly stated the Fed’s intention to keep the benchmark federal funds rate within a range of 5.25% to 5.5%, representing a 22-year high. However, he refrained from providing any explicit indication about future interest rate hikes. Powell likened the current economic scenario to navigating by the stars in cloudy skies, pointing out the uncertainty surrounding the neutral rate of interest. As a result, the exact level of monetary policy restraint remains ambiguous.
It’s never great (especially for those of us who remember them) to see the 1970s make their way into a discussion on inflation, but Hassett too has not been shy about mentioning that decade’s inflationary trauma.
Another wave of high prices could be coming for the US economy, thanks to factors like hefty government spending and high energy costs, according to one former White House economist.
“I think we’re going to see kind of a saw-toothed inflation cycle,” Kevin Hassett, the Council of Economic Advisers chairman during the Trump administration, said in an interview with CNBC on Tuesday. “We’re going to see another inflation wave that’s going to be stimulated by high growth and by higher energy prices…
But there are still lingering price pressures in the economy that could bring on a resurgence of hot inflation, Hassett warned. GDP is set to grow nearly 6% over the third quarter, according to the Atlanta Fed’s most recent estimate, with Hassett predicting a 30%-40% chance GDP growth will clock in higher than real interest rates in the economy.
That level of economic growth is inflationary, and prices have already gone up in key sectors. Energy prices, which alone make up around 8% of the CPI, have risen, with the average price of a gallon of gas increasing to $3.82 on Tuesday, according to AAA.
“There’s just no way that inflation is going down when you get something like that, combined with deficit spending that’s just absolutely insane,” Hassett said of strong economic growth. When including the latest data, inflation is likely hovering around 5%, well above the 3.2% recorded in July, he added.
“I think the Fed is going to have to hike quite a bit more,” Hassett said.
In Hassett’s view, interest rates could “for sure” rise to 6%, a level unseen since December 2000 and something that most investors likely haven’t priced into assets. As of now, investors are only pricing in a 5% chance interest rates could touch 6% by the end of 2023, according to the CME FedWatch tool.
I don’t think that today’s jobs data are going to change Hassett’s mind.
The Wall Street Journal (September 1):
Hiring slowed this summer and unemployment rose in August, signs the labor market is cooling in the face of high interest rates.
U.S. employers added 187,000 jobs last month, while payrolls in June and July were revised down a combined 110,000, the Labor Department said Friday. Over those three months, 150,000 jobs were added monthly on average, down from a 238,000 average gain in March through May…
The report keeps the Federal Reserve on track to hold rates steady at its meeting this month, but won’t resolve a debate over whether to raise rates again in November or December. Other data show the broader economy remains strong, with consumer spending surging this summer and inflation easing.
The recent payroll increases are far below the roughly 400,000 average monthly gain in 2022. The unemployment rate was 3.8% last month, up from 3.5% in July—reflecting more Americans entering the labor market.
Workers’ average hourly earnings rose 4.3% in August from a year earlier, down from 4.4% in July, but well above the prepandemic pace.
Meanwhile, this piece on the Rational Walk caught my eye:
The narrative from the Federal Reserve is that the two percent inflation target is intact and officials are dedicated to moving toward that goal. However, lately it seems like there have been efforts to move the Overton window toward a higher target.
On August 20, Jason Furman argued in favor of a three percent target on the opinion pages of the Wall Street Journal. Two days later, Nick Timiraos, perhaps the reporter with the best sources inside the Eccles building, wrote a news article about how hard the Fed should “squeeze” to achieve the two percent target.
The Boston Globe’s editorial board is pushing in a similar direction. Commenting earlier this week on Powell’s remark (from June) that there was still a “long way to go” until inflation hit the Fed’s 2 percent target, it questioned how important that target really was:
There’s only one problem with Powell insisting that there’s still a long way to go: It’s that his destination — the 2 percent inflation target — is not some unimpeachable marker of price stability but an arbitrary one inspired by, believe it or not, an off-the-cuff comment New Zealand’s finance minister made in a television interview in 1988.
After being pressed on whether the country’s trouble with inflation had been brought under control, the finance minister said that he wouldn’t be satisfied until the country’s inflation rate was brought down to somewhere between 0 and 1 percent. That prompted New Zealand’s central bank to figure out what a reasonable target would actually be, and after some research — which one of the central bankers from that time would later admit “wasn’t ruthlessly scientific” — economists landed on the ideal inflation target to, at maximum, be 2 percent. New Zealand became the first country to mandate a numeric inflation target, and other central banks soon followed.
By 1996, a 2 percent inflation target had become an unwritten rule at the Fed, and in 2012, then-Fed chair Ben Bernanke made it official. Of course, price stability has always been part of the Fed’s mandate, but before any of this happened, the Fed had never been fixated on such a specific number. After inflation had been brought down from double digits to 4 percent in the 1980s, for example, the Fed more or less considered its mission accomplished.
More or less. Maybe. It’s been a while since I read Paul Volcker’s (excellent) autobiography, but if I recall correctly, he wasn’t too satisfied with 4 percent.
The Rational Walk highlights this passage from Volcker’s autobiography:
A 2 percent target, or limit, was not in my textbooks years ago. I know of no theoretical justification. It’s difficult to be both a target and a limit at the same time. And a 2 percent inflation rate, successfully maintained, would mean the price level doubles in little more than a generation.
Like the Boston Globe’s editorial board, I can see the argument for a 2 percent target. We should not let the perfect be the enemy of the good, and there is some merit (I wouldn’t put it any stronger than that) in allowing for a little (caveats apply) inflation as, to quote the board, “a buffer against deflation.” That may be so even if fixing a magic number can come, as Volcker points out, with certain illogical consequences.
Nevertheless, to move the target up from 2 percent would send the wrong signal at the wrong time. And so would following the Globe’s advice that the Fed should not be in “such a rush” to get back to 2 percent. It is worth remembering, incidentally, that Volcker himself started easing monetary policy in April 1980 (the country was in recession), only to have to sharply reverse direction within months when it became apparent that inflation was very much alive.
Meanwhile, the Rational Walk adds sternly (and not incorrectly):
The reality is that the Federal Reserve has a price stability mandate and Congress has never authorized the Fed to destroy two percent (or any other percent) of the value of the dollar annually. As I wrote a few months ago, the Humphrey Hawkins Act of 1978 is quite clear about what price stability actually means.