The editors of the Wall Street Journal articulate the problem the Fed is facing:
The Federal Open Market Committee (FOMC) is meeting this week, and its members were greeted Tuesday with the rude welcome of surging wholesale prices. This is more evidence that Chairman Jerome Powell and the Federal Reserve have made a historic mistake that they now have to fix without sending the economy into recession.
Prices for final goods increased 9.6% year-on-year in November, up from 8.8% in October. The nearby chart shows how wholesale prices have risen every month but one this year on an annual basis, and across most major goods and services. Producer prices tend to flow into consumer prices, which were up 6.8% year-on-year in November.
along with the risks of waiting longer:
Mr. Powell no doubt hopes that inflation will ease next year, and that he can then raise rates more slowly. But the longer he waits before he acts, the more he runs the risk that he’ll have to slam on the brakes even harder. This is what happens when the Fed takes its eye off its inflation mandate and prices take off.
Said another way, the longer they delay the more likely they will need to throw the economy into recession to solve the problem they’ve created. And it won’t be a recession like any of the Fed governors and relatively few members of Congress will recall. The “pump-priming” which is their reflex will actually aggravate the situation.
I think the underlying problem is that none of the present Fed governors have adult memories of the late 1970s and early 80s. Mr. Powell was barely out of law school at that point. All they’ve ever known is low inflation.
The 2021 federal budget is $6.8 T, of which $3.0 T is deficit spending. The total debt is $28.4 T, which is 136% of US GDP.
Since the fed is financing the annual deficit, I don’t see how they can fight inflation without a big recession and crashing the stock market. I remember the Volker years. Adjustable rate mortgages, the only kind available, hit 21% apr. People were forced out of their homes.
Add in some big wars in Ukraine, the Persian Gulf, and Taiwan, and we’ll have some real fun.
The Russian foreign ministry issued what reads like an ultimatum to US/NATO regarding Ukraine, troop deployments and nuclear weapons. They are demanding negotiations begin on all these matters immediately. Summaries are available at Moon of Alabama and The Saker.
Bob has the answer.
The most analogous situation is not the 1970’s but the late 1940’s. If there are few Fed governors that remember the 70’s; almost no one remembers the Truman years.
But back then, the Federal debt to GDP ratio was 100+%; federal deficits were 10+% for multiple years due to a national emergency; and inflation spiked above 6% twice.
In both spikes in the late 40’s, the Fed was formally constrained by Treasury from fighting inflation with full force to avoid compromising the fiscal position of the Federal Government.
The fed gained its full independence in the noted “Treasury Fed accord” in 1951 — but that was after years of inflation and economic growth had reduced the debt to GDP ratio to 60%.
I doubt Congress would have the stomach for the Fed to fight inflation in full force if it implied the Federal government must cut spending/raise taxes by 100+ billion due to interest rate expense. And the Fed in the end is a creature of Congress.
And don’t forget, 30 trillion dollars of debt is also 30 trillion dollars of assets to whoever owns the treasuries. Raising interest rates lowers the “mark to market” value of that debt. If not done carefully, disorderly devaluation of the debt could cause systemic issues.
“Since the fed is financing the annual deficit, I don’t see how they can fight inflation without a big recession and crashing the stock market.”
As I commented about a month ago: they, and the Administration, are in a box. Aggregate real wages are down 2% (and probably more, since the CPI/inflation stat has been cynically understated). And people feel it. People with a $500K retirement egg will in all likelihood see their purchasing power decline more than their SS check. Even TIPS are only a partial hedge.
The notion of keeping home price and equity values up is nice – own real assets and such – but the last great equity decline came in an inflationary environment. Will the Fed allow double digit MM Fund returns? All you can do in an inflation fighting mode , as CO points out, is let rates rise. Equities down. Mortgages expensive. Long durations down. 1 year money (and less) becomes reflective of reality. Savers are hosed; fixed incomers are hosed; debtors win……for awhile.
The Administration’s approach appears to be deny, deny, deny, and hope there are a sufficient number of steverinos out there who will polly parrot their words.
Jimmy Carter finally has the monkey off his back.