Allen Blinder does a pretty good job of outlining the goals in his latest Wall Street Journal op-ed:
The Fed is trying to engineer a soft landing by the end of next year, with unemployment about where it is today (3.6%) and inflation down to 2.6%—as measured by the Fed’s favorite index, the inflation rate for personal consumption expenditures excluding food and energy, or core PCE for short.
How likely is the Fed to achieve those ambitious goals?
but it takes him quite a while to get around to the point:
The bloody conflict in Ukraine is already driving food and energy prices higher, which will boost headline inflation in the coming months. Core inflation won’t be immune because food and energy prices seep into virtually all other prices, albeit in muted form. What product doesn’t include energy in its cost, either directly (to keep the lights on) or indirectly (via delivery trucks)?
Beyond that, the longer inflation remains high, the more it gets embedded into wages and other contractual arrangements. When workers see inflation coming, they want to be compensated for it. And once higher inflationary expectations get entrenched, they affect price- and wage-setting throughout the economy, making a soft landing harder to achieve.
Fortunately, expected inflation doesn’t appear to have gotten out of hand, at least not yet. The 10-year “break-even†inflation rate implied by bond prices is only 2.8%. That’s a bit higher than the Fed would like, but only a bit. The key questions: How long will the expectations dam hold if high inflation continues? If the dam breaks, how much will the Fed have to raise interest rates to beat down inflationary psychology?
Before the war, it looked as if the Fed might glide by. Inflation appeared likely to turn down soon, and expectations of future inflation probably would have followed. Now, unfortunately, that optimism looks rather out of date.
So let’s all join Lefty Gomez in wishing Jay Powell and company good luck. They’ll need it.
Lefty Gomez was a Yanks pitcher who famously and humbly declared that he’d “rather be lucky than good”. I strongly suspect that the FOMC is not nearly as good as they think they are if only because things have changed drastically over the last 40 years. 40 years ago the Fed was able to bring runaway inflation down by using the levers at its disposal, producing a sharp recession in the process. Will today’s Fed under today’s conditions be able to curb inflation without a steep recession? Or could it produce a steep recession without curbing inflation? Right now there’s a lot of gambling being done under the assumption that the Fed is both lucky and good.
I wonder if it dawned on Mr Blinder that he makes the case that exclusion of energy and food is pure sophistry with his citations of the intensity and pervasiveness of energy and food costs.
“Inflation appeared likely to turn down soon, and expectations of future inflation probably would have followed. Now, unfortunately, that optimism looks rather out of date.”
Says who? The “transitory” crowd? Nobody knows how much or how long the effects of the massive spending and treasury buying binge for covid will/would last. But the evidence pre-Ukraine was that it was a train with a lot of momentum. And Mr Blinder has no idea how much recession is reflected in the 10 year.
Blinder appears to have written a political plea for hope. The only thing he said worth noting is that Ukraine has piled, on top of bad policy, a supply shock.
I have no special insight on recession other than an appreciation for how much rate hikes will effect time financed assets: homes, rents, cars and other big ticket durable goods.
A while back I made reference to a portfolio company sale that would be a huge windfall for the firm. It has closed most satisfactorily. It was construction related and in the SE. It continues to perform well, but selling was the right decision, unless you like playing musical chairs. We are seeing a number of such companies coming to market right now. The current bet appears to be biased towards recession.
Pretty much.
What caught my eye about the op-ed was that he doesn’t factor in any risk that Fed actions in 2022 won’t be as effective in curbing inflation as they were in 1980. A key point is in an apt assessment I read some time ago to the effect that for some time the United States has been importing consumer goods and deflation from China and exporting jobs. If that is a factor in the present inflation, the Fed’s actions may be disappointing.
“Fed actions in 2022 won’t be as effective in curbing inflation as they were in 1980”
Yes. There’s a few factors that were different than 1980.
1) China is barely controlling Omicron. Already Shanghai (a big manufacturing / logistics hub) has been in lockdown for 3 weeks and probably for several more weeks. So more logistics issues. Also, China will likely gone through the “COVID-wave” impacts that the US gone through — WFH and other cultural shifts that increase demand for goods. That of course would reduce the supply of goods for export.
2) Global stockpiling. Given the tense markets involving food, energy and strategic materials, and the tense geopolitical situation, it makes sense for governments / companies to stockpile, regardless of economic inefficiency. I wouldn’t be surprised if multiple countries are trying to increase their strategic energy reserves while US releases theirs. Again, increase demand, less supply.
3) War. Having hundreds of billions dollars of infrastructure destroyed, and crippling European industry is inflationary. And given Europe is a net exporter to America, that’s bound to create inflation here.
4) Higher debt. Net debt (household, government, corporate) is higher as a % of GDP then 1980. Its possible the Fed could trigger a debt crisis before rate hikes kill inflation.
I guess we’re going to find out whether the Fed alone is sufficient to deal with inflation; because it doesn’t look like we’ll do much on the fiscal side, the regulatory side, or the foreign policy side to deal with inflation.
” A key point is in an apt assessment I read some time ago to the effect that for some time the United States has been importing consumer goods and deflation from China and exporting jobs.”
A point I’ve been making for years now. I know you believe corporations have captured most of the benefit, but a graph you posted here recently shows the downward trend in prices of many consumer goods.
I can only speculate as to motivations. Some will cite the raw number of Chinese bodies to sell to, but I think that’s an illusion. My speculation is that the politicians need cheap imports to keep the marching torches and pitchforks at bay as real wages have fallen.
World events have now intervened in the Washington pol and Fed high wire act. You can only neglect fundamentals for so long. This could be an inflection point. One in which political considerations need to be set aside and basic country needs addressed. We can’t afford Green New Deal and Woke Nonsense right now. I don’t see evidence Jow Biden or the dominant Progressive wing doing that.
The Chinese authorities have arrived at a clever way of controlling the number of deaths due to COVID-19: stop reporting them. Does anyone actually believe the statistics they are reporting?
IMO trying to control inflation in a single country in a globalized economy is futile. WRT fiscal and regulatory steps my concern is that whatever actions are taken will be perverse in their outcomes. It’s a simple case of sticking to what you know and what they know was folk Keynesianism (spending money always stimulates the economy) and now it’s folk MMT (you can spend as much as you want without adverse economic consequences).
When I argued against that point-of-view decades ago, my point was that prospective customers are defined as people who are willing to pay. Back then China wasn’t a country with a billion prospective customers; it was a country with a few thousand prospective customers and a billion people who weren’t prospective customers.
Now there are more prospective customers but it’s still not one with a billion customers for the simple reason that you also need to be able to make a purchase decision to be a customer and the number of people in China who can make purchasing decisions is still well below a billion. Nearly every American company who has tried to do business in China has learned that.
“Does anyone actually believe the statistics they are reporting?”
I mostly have — since around Feb 15, 2020, the Chinese data has been pretty accurate. Indeed, the lived experience in China is in alignment with a society that almost had 0 cases of COVID. You will have to accept my statement on that.