Higher interest rates remain the only solution, however uncomfortable.
The government released new data for the Federal Reserve’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, and it’s not ideal. As of July, PCE is up by 3.7 percent year-over-year. Core PCE, which excludes volatile food and energy prices (can’t blame the Iran war), is up by 3.3 percent. Both measures are well above the Fed’s stated inflation target of 2 percent — which it hasn’t achieved by any metric since the pandemic — and are elevated from last year’s rate of increase.
Kevin Warsh is set to deliver the Fed chair’s annual speech in Jackson Hole, Wyo. on Friday. Markets have little clue whether he thinks persistent inflation is due to monetary policy that remains too loose (which it is), or if he will claim transient forces as an excuse. At least three of his colleagues on the Fed’s governing committee think it’s time to tighten at last.
Meanwhile, Treasury Secretary Scott Bessent is battling the bond market, which increasingly expects rate hikes soon, by buying back long-term debt. He is likely to lose this crusade against the price system. Regardless, Warsh is probably getting the White House’s message loud and clear: Keep interest rates where they are, no matter the inflation data.
In a complex and interconnected economy, we cannot have all nice things at once. Higher rates from the Fed will raise federal borrowing costs. But they are also the only effective tool at the Fed’s disposal to slow money-supply growth and tame inflation under the current ample-reserves regime. (Quantitative tightening, or asset sales, would have little effect when trading Treasury bonds for unloaned bank reserves that are already parked at the central bank.)
Without monetary tightening, inflation will stay too high, and Americans will stay furious about it. The Federal Reserve’s mandate is not to cover for our fiscal incontinence, but to restore price stability. If only it had the will.