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Fed Watch: Policymakers Take Tiny Steps As Inflation Overheats

By Investing.com (Darrell Delamaide/Investing.com)Market OverviewMar 21, 2022 04:45AM ET
www.investing.com/analysis/fed-watch-policymakers-take-tiny-steps-as-inflation-overheats-200620430
Fed Watch: Policymakers Take Tiny Steps As Inflation Overheats
By Investing.com (Darrell Delamaide/Investing.com)   |  Mar 21, 2022 04:45AM ET
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Someone has finally used the word "absurd" in reference to the Federal Reserve’s policy of gradual interest-rate hikes to combat inflation as the year-on-year consumer price index is about to cross the 8% threshold.

You can say what you like about Larry Summers, but the former Treasury secretary and director of the National Economic Council, who spends most of his time at Harvard when not in office, is a smart economist.

He had this to say about the Fed’s apparent plan, after mocking policymakers’ projection of three years of 3.5% unemployment as something not seen in about 60 years and "highly implausible:"

"But that is not the central absurdity in the Fed forecast. The chief problem is the idea that a super-tight labor market will somehow coincide with rapidly slowing inflation."

This is a stretch even in the Keynesian tradition that Fed economists use, making labor markets the basis for forecasting inflation. But in a monetarist framework, Summers writes in the Washington Post, you have to raise real rates to reduce inflation.

However, the Fed’s gentle, gradual plan to raise rates by a quarter-point in successive meetings of the Federal Open Market Committee actually results in a decline in real interest rates—that is, the nominal rate minus inflation. As Summers wrote:

"The FOMC’s plans do not even call for keeping up with the rising inflationary gap. It is hard to see how interest rates that even three years from now will be about 2 percentage points less than current rates of inflation can reasonably be regarded as providing sufficient restraint."

Even ahead of last week’s FOMC meeting, Summers had warned that the Fed was on the wrong track with its plan to raise rates only a quarter-point.

"I believe the Fed has not internalized the magnitude of its errors over the past year, is operating with an inappropriate and dangerous framework, and needs to take far stronger action to support price stability than appears likely."

The consequences, in his view, are years of stagflation with 5% inflation and 5% unemployment, ending eventually in a recession. Real rates need to reach 2 or 3%, which would mean nominal rates of 5% or more even in a best-case scenario, according to Summers.

St. Louis Fed chief James Bullard dissented from the FOMC vote for a quarter-point hike last week, arguing that a half-point hike would have been a better choice given the high inflation rate. Even with the Fed’s conservative benchmark—core inflation on the personal consumption expenditure index stripping out food and energy costs—annual inflation is 5.2%, 320 basis points above the 2% target.

Bullard is urging a policy rate of above 3% by the end of this year for overnight fed funds, instead of the 1.875% rate projected by the committee as a whole.

“US monetary policy has been unwittingly easing further because inflation has risen sharply while the policy rate has remained very low, pushing short-term real interest rates lower. The committee will have to move quickly to address this situation or risk losing credibility on its inflation target,” Bullard said in a statement explaining his dissent.

That should probably be in the past tense—the Fed has already lost a lot of credibility.

Bullard believes the US economy is resilient enough to sustain this kind of hike in interest rates. However, Bill Gross, the former asset manager at Pimco, who made a fortune for himself and many others by navigating interest rates in his massive bond fund, has a different view. In an interview with the Financial Times, Gross explained:

"I suspect you can’t get above 2.5 to 3% before you crack the economy again. We’ve just gotten used to lower and lower rates and anything much higher will break the housing market."

Even the cautious members of the FOMC are projecting a 2.8% overnight interest rate by the end of 2023, so Gross’s forecast does not leave them much room for maneuver.

Powell's Legacy On The Line?

The US Senate flexed its muscles last week and killed the nomination of Sarah Bloom Raskin to be Fed vice chair for supervision. West Virginia Democrat Joe Manchin came out against confirming her because of her outspoken position that US banks should cut off support for fossil fuel companies. With all Republicans opposed, the single Democratic defection tipped the scale in the 50-50 Senate.

Even though Raskin, who had won the Senate’s nod twice before for posts at the Fed and the Treasury, said at her most recent confirmation hearing that she would not enforce that view in her new position, opponents weren’t buying it.

Ironically, her withdrawal from consideration freed the Senate Banking Committee, which Republicans had boycotted on her account, to vote on the other four pending Fed nominations, including that of Chairman Jerome Powell for a second term.

The Senate is not likely to deny Powell that second term, but his legacy is on the line. If Summers and Bullard and like-minded economists are right, history will not be kind to Powell.

Fed Watch: Policymakers Take Tiny Steps As Inflation Overheats
 

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Fed Watch: Policymakers Take Tiny Steps As Inflation Overheats

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Comments (8)
Kochar Bipin
Kochar Bipin Mar 21, 2022 7:52PM ET
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The current spurt in inflation is due to the abysmal failure of the Biden administration to lower energy costs - a simple task given the huge amount easily tap able resources in US. Sadly, no monetary policy cannot cover up for such administrative disasters. Fed's goal needs to remain to minimize the impact of such disasters on the people and provide President Biden more time to deliver on his promise to tame energy prices.
Sevantilal Patel
Sevantilal Patel Mar 21, 2022 12:24PM ET
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Summers is probably right. quarter point increase is like watching grass grow. what Fed is afraid of. lowest in employment is on fed side. this liquidity and impossible to buy house is due to trying to create wealth effect. should try to produce more at home to control the I'll counted CPI. not produce more money.
Bhagwan Dass
Bhagwan Dass Mar 21, 2022 11:57AM ET
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if us president cannot handle inflation.why he is sitting in white house
Bhagwan Dass
Bhagwan Dass Mar 21, 2022 11:52AM ET
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what Biden will do in polland.I want to Clapp him. third class president
Peter ONeill
Peter ONeill Mar 21, 2022 9:54AM ET
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The market actually celebrating the war in Ukraine as it might mean the Fed is slower to increase interest rates. Ignoring the fact that inflation and supply bottlenecks will actually increase by large margins over the next 2-3 months -as energy and food prices increase even further due to sanctions versus Russia. Could easily have 10%+ inflation by the summer and then the Fed's hand really will be forced to get serious on inflation (will need to if Dems have any chance at all of saving their Nov midterms).
DE SP
DE SP Mar 21, 2022 8:03AM ET
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The Wizard of OZ - ehr, I mean the FR - is but smoke and mirrors who can do nothing but apply pyschology tricks to investors. The markets are so big, they are insignificant in any event. And when things truly get seriously bad, the FR just starts lying. So nothing to see here.
jason xx
jason xx Mar 21, 2022 5:39AM ET
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It's not a tiny step they haven't even given the end of stimulus bond buying a chance to work on inflation not to mention recovery from pandemic
dar dar
dar dar Mar 21, 2022 4:53AM ET
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apr should be 8.5 minimum for 20 years go into depression for 5 years to pay for our greed
 
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