In the second half of 2022, inflation was quite moderate. This was true of Consumer Price Index (CPI)the personal consumption expenditure (PCE) price index, and, as announced today, the producer price index (PPI). Falling inflation is the reason why in the long run interest rates fell and the stock market rose last week when the October CPI was released; today’s PPI report just confirmed it.
So why is the Federal Reserve continuing to raise short-term interest rates so aggressively? Part of the answer is simply a communication problem. Most media reports on inflation over the past 12 months, which still includes the rapid price increases earlier this year. Such misrepresentations, in turn, led to this disastrous Washington Post op-ed just before the November 2 Fed meeting:To defeat inflation, the Fed may need to trigger a recession.
Here’s why I think the Fed is overreacting to inflation and risking an unnecessary recession:
First, too many very serious people in the media construct narratives from outdated numbers, which limits the Fed
Of course, the Fed doesn’t need to listen to the Washington Post or any other financial publication. The Fed has the best financial economists in the world, so why would they feel pressured by misinformed editorials and media speculation?
Because the media hype is creating a narrative that if the Fed did the economically appropriate thing – like halting rate hikes for 4-6 months to see how the economy and inflation fared – it would be derided as “weak about inflation” or “policy” or something like that. The Fed can’t have that, so it basically has to play with stupid editorial narratives.
Second, Fed economists initially underestimated inflation, even before the Russian invasion of Ukraine.and they don’t really know whywhich leads them to a “Prevention is better than cure” position on inflation.
I think the Fed initially understated post-Covid inflation because it understated “monopoly” or “me too” price increases far beyond the “cost plus” inflation that affected businesses. In other words, the Fed (and many others) did not predict that so many companies would raise their prices far beyond the increases warranted by their post-Covid supply costs.
This one is a bit tricky, so I’ll try to untangle it. All economists knew there would be transient “cost-push” inflation as the economy rebounded from the Covid meltdown. For instance, shipping cost increased as supply chains tried to restart, inventory issues were severe, and more.
But consumer prices appear to have been raised by many companies far beyond these true underlying cost increases, primarily because businesses learned they could get away with it. With supplies still at least partly constrained, they could raise prices without being undercut by competitors, as potential competitors could not obtain enough product to compete.
Conclusion. Hopefully the media will start to understand that the most recent month’s inflation report shouldn’t be presented as the data for the past 12 months, and the Fed will pause to raise short-term interest rates to lows. rates as fast at their December meeting. .
I fear that we are already entering a recession. But we need to get the message across that inflation is already coming down, and as competition picks up, “me too” price increases will also start to come down. The Fed should take a deep breath, ignore pundits and columnists who don’t quite understand the data, and see how it plays out for a while before causing unnecessary economic hardship.