I'm beating a dead horse on this topic, but here is inflation in the US over the past three years:
In 2022 the Fed began raising interest rates. By June, rates went above 1% for the first time.
In July monthly inflation abruptly fell off the map and then stayed steady around 3% for the next two years, all while the Fed kept raising rates and then kept them high.
Quantitative tightening followed the same pattern. It began in May and didn't hit -2% until July. By then inflation had already tumbled.
If you track PCE inflation instead of CPI you get the same result.
In light of this, does anyone still think it's credible that Fed actions had any serious impact on bringing down inflation? Or that loosening policy is likely to raise inflation? Please explain in 50,000 words or less.
Hell hath no fury like those who lost cheap money?
Or lost trend lines....
This chart shows something hidden by "headline" year-over-year inflation. Inflation was ramping up the day Biden took office. He didn't cause it, he inherited it.
In our current housing market situation, where there is a massive undersupply of housing, cheap money will result in faster housing price inflation. That will then bleed through, to some degree, into regular inflation within a couple of years.
But overall I don't think it's a huge concern, despite all my harping about how unmoored (or unanchored) housing prices are (for structural reasons).
But this should result in less demand for rental units and perhaps (probably) lower rental costs. So the direct impact is actually lower housing inflation, perhaps significantly lower. How this plays out and bleeds into overall inflation is a bit of a crapshoot.
Its a bit unintuitive, but one direct impact of higher rates is to increase the rate/cost of housing/shelter component in the inflation calculation. The list price of homes for sale doesnt actually impact the inflation stat at all.
...no? That's not how it works. Housing is a replacement good - people either buy or rent, (mostly) not both.
If I can buy a house for a $3000 mortgage payment vs. rent one for $3000, of course I would buy. If interest rates go up and that same house is now a $3500 mortgage payment (even if the sticker price declines somewhat, which hasn't been the case in the places where most people actually live), then there is more demand for renting, as well as a new price equilibrium. The price of rent will go up as more people choose to rent instead of buy (and where I live, apartments collude to maximize rent increases via Realpage while SFH rentals use cost of a mortgage as a benchmark for what to set the rent at). Eventually, the price of renting (and people's calculus of opportunity costs and other pros/cons) will approach or surpass the price of a mortgage and bidding wars for housing will heat up again.
Because we have such constricted supply (those bidding wars and cash offers are always there now, even in the high interest rate environment), this can only be a positive (as in ever-increasing) feedback loop.
We're seriously fucked.
You went from a narrow claim that "The Fed played no role in our recent bout of inflation" to a broad macro claim that the Fed has no serious impact on inflation.
I thought you'd be more careful than that, given your past citations of Friedman's "long and variable lags" of monetary policy, which implied that monetary policy had an effect on prices.
[93 words, including cited excerpt]
Agree. I'd have some humility if I had publicly said inflation would be gone by spring 2022.
"In light of this, does anyone still think it's credible that Fed actions had any serious impact on bringing down inflation? Or that loosening policy is likely to raise inflation? ..."
It is easy enough to make up a story about expectations in which Fed actions affect inflation.
Anyway you have been predicting for years that the Fed was going to cause a recession. If the Fed actions had no effect on inflation maybe they aren't going to cause a recession either.
Also inflation was a world phenomenon so the Fed’s role couldn’t be that impactful regardless. However, because of the nature of capital allocation, there is a persuasive argument that the interest rate should always be above the rate of inflation. Now, that doesn’t mean every single time, and rates adjustments should not be chasing short or mid term fluctuations, but I think there is a consensus that Fed rates on the long term should be anywhere between .50 and 2.00 above YTY inflation with 1.25 being the sweet spot. There is no doubt that the rate today is just too high. For the near future I predict a 3.5 rate and a 4.5 mortgage rate for the affluent (very good credit).
Why would institutions purchase 4.5% mortgages in an environment in which monetary degradation is Federal policy?
Sure, no one in the government is "promising" consistent inflation of three or four percent, but both parties are pursuing economic policies which DEMAND and implicitly ASSUME such inflation, in order to afford their dissimilar-in-detail but otherwise identical fiscal policies of deficits in excess of GDP growth.
As long as the Uniparty policy is as it is, the Federal Reserve will be fighting a rear-guard battle against looming bouts of rapid inflation triggered from time-to-time by "bumps in the road" like the Pandemic.
One party or the other needs to be brave enough to shrink the current deficit enough that the rate of accumulation of debt falls below the current rate of economic growth. That means disappointing some sectors of society, but it's better than presiding over the pain of a weak and further-weakening currency for a society that imports so many of its necessities.
Let me see if I've got this right. The Fed started raising rates and inflation fell shortly after. Therefore the Fed raising rates had no effect on inflation.
I think you need to work on your logic.
In reality, the Fed started raising rates before June - that's just the arbitrary point you chose when they exceeded 1%. One could argue from this data that the Fed didn't need to continue raising as aggressively as they did, but that's a whole other argument. And, of course, hindsight is always 20/20.
1% is arbitrary, but June is important as it is the first time that the Fed gave official forward looking expectations showing that significant increases in rates were coming. Prior to June, the Fed predicted a slow increase with rates topping out in the mid 2's in 2023/24. After June, the world knew that the Fed planned to be restrictive.
It is equally the case that one needs to have an eye on what global peer central banks did and have been doing.
(of course as Drum has continued to make fallacious statements about timing impact
Really this is well into crank territory, along with his now disappeared 'unskewed' trend lines (one supposes he finally silently admitted their ridiculousness).
Unlesss one is also advancing the hypothesis of US being a unique economy, one can and should look at peers, ECB, BoE, and global rate rises as the leading trading currency central banks acted in close timing so a single country analysis in face of a global issue (that the post-pandemic t- Ukraine war inflation acceleration certainly was) is bound to be one that is at best limited if not potentially quite crippled, although one grants US size can often make it a case in itself.
The Turkish example where Erdogan's central bank rather behaved like the Drum type thinkers have desired is a counter-example until recently (a spoiler, not a flattering inflation story).
The Fed started raising rates and inflation fell shortly after.
Biden signed the Inflation Reduction Act at the peak of inflation and inflation dropped immediately. It's right there in the name of the law. Maybe it was the IRA that brought down inflation.
If you just look at global oil prices, you'll find it mirrors inflation quite closely. There was a large spike in February 2022 caused by the Russian invasion of Ukraine. Prices settled back to a more normal level around the middle of the year.
Of course not. The New York Times is all over it. Supply and demand rule the day!
"For others, “price gouging” suggests that companies are choosing to produce less — effectively keeping something in short supply — so that they can charge more. At least in theory, such a situation should be only temporary. New competitors should enter the market and provide products at a price people can afford."
New competitors. Bless their naïve little hearts.
This seems like the kind of crude argument that climate change deniers make. They'll present a graph that shows global mean temperature changing a lot in the distant past and then snidely ask " In light of this, does anyone still think it's credible that human activity is warming the planet?"
And the answer is: Yes. But it's complicated, and it's possible for deniers who just don't want to believe it to arrange and annotate graphs in a way that conceals it.
Sometimes you'll get two guys, neither of whom knows the first thing about climate science, arguing about it. One's more right than the other, but really, neither of them is equipped to bring any real understanding to the "discussion." It's just two parrots squawking at each other, and one happened to get trained on the mutterings of a smarter owner.
So before anyone gets up in my face about this, let me ask: Are you an economist? I'm not. Can you instead just point me at the most serious and credible economist you know of who advances the argument that central bank interest rates are entirely uncorrelated to inflation? I'm keen to read what this person has to say, in the unlikely event that she exists.
"In the unlikely event that she exists"
Bingo.
The Fed played no role in our recent bout of inflation
What next? Are you going to tell us that the Fed's multiple cycles of quantitative easing during the previous decade had little impact in terms of hard economics but was all about the vibes?
Of course, monetary policy matters and good policy can lead to better outcomes, but there's a mythology that has been built up around the Fed, its role, and its wisdom (which can be infinite or nonexistent, depending on your point of view -- or how the market reacts) that speaks to our need for some trusted figure that knows how to read the tea leaves and can guide the way. There are times the Fed performs the same rituals for our society as the Oracle of Delphi performed for the Greeks. "One of the main stories claimed that the Pythia [the Oracle] delivered oracles in a frenzied state induced by vapours rising from a chasm in the rock, and that she spoke gibberish which priests interpreted as the enigmatic prophecies and turned them into poetic dactylic hexameters preserved in Greek literature."
The best explanation I've heard (in a PhD-level macro survey course at Stanford) is that the Fed's control is like a string: they can PULL on it (to curtail economic activity and even cause a recession), but it does no good to PUSH on it (to stimulate economic activity) unless other expansionary forces are at work.
So you'd be right that they can't "cause" inflation: what they can do is "release the string" faster than they should so that the economy expands faster than they'd prefer. But they certainly CAN cause disinflation or recession, by tightening credit sufficiently.
You know this is heresy, right Kevin? And not just heresy, it's damnable heresy.
So, would someone enlighten me as to what happened in about July 2022? Is that when the port of Los Angeles got de-bottlenecked and the container ships from China lying offshore all got in to unload?
Whatever the debate over the Fed and inflation you're having, a break in the trend that dramatic deserves an explanation. Thank you.
If I had a hammer...
I wouldn't say it didn't play any role...it's just that things are complex. As others here have pointed out, housing inflation could have been exacerbated by the Fed's actions. The recent stock market tumble was, in part, caused by investors having to unwind positions taken to exploit the rate differential between US and Japan--which was propping up the dollar and helping lower inflation (cheaper imports). That's probably something not covered in Econ 101. For that to have such an impact is an indicator that there's too much investment capital and bots are running the system.
If the Fed has credibility as a central bank, the announcement and forward guidance should have effects on pricing behavior. This is fairly standard in the macro/monetary literature and supports the idea that, yes, the Fed DID have an impact on inflation.
These kind of unmeasurable, untestable, magic powers are central to some peoples idea of how the economy works. It doesnt really hold up very well in this case, but its hard to shake these faith based theories.
The general forward guidance didnt seem to be successful in eliminating inflation in 2021/2022. Surprising and somewhat dramatic changes in forward guidance around mid-2022 appear to have had an impact even before the announcements were made.
- You don't show anything before 2021. The inflation rates of 2020 were not 5% or 4%, they were around 2%, and they had been there for decades. Draw a big red horizontal line at 2%, and the right side of the chart doesn't show that everything has been fine.
- You are showing the CPI with food and energy included, which gives a generally noisy and misleading picture when you're looking at month-to-month changes. The only thing that suddenly changed in mid 2022 was energy prices, which dropped for the next twelve months, but that wasn't going to continue. Core inflation didn't start to look close to normal until mid 2023.
- You don't chart what inflation would have done if the Fed hadn't raised interest rates. Well, we don't know, do we?
Kevin, you aren't beating a dead horse. You're swatting a live horse with a fly swatter, and he's holding up pretty well.
None of these make sense.
1) The discussion is the disinflation that has occurred over the last few years. That higher inflation occurred in 2021 and early 2022 is well known is central to the discussion of the following disinflation. Nobody is hiding anything.
2) This is largely due to the outsize role that shelter/ housing plays in core CPI. Given the 12-18 month lag in this shelter data and the rapid changes in the cost of rent post pandemic, monthly core CPI can be quite misleading. CPI and core CPI track pretty well since fall 2022. All of these would be better shown as a rolling 2 or 3 month average, but just like choosing core-CPI instead of CPI it doesnt change narrative. CPI less food, energy and shelter looks very, very normal beginning in early 2022, before the FED ever raised rates.
3) This doesnt make any sense. 'I dont like your facts because you can't show what would have happened in an alternate universe where the actions and data were different" is never a sensible argument.
My point (3) is not expressing any dissatisfaction with the actual facts. But it is not valid reasoning for Kevin to observe that good things happened after the Fed raised interest rates, and to conclude therefore that the Fed shouldn't have acted. There's a great chasm in the logic there. I'm only saying we don't know what would have happened if the Fed hadn't acted, so Kevin didn't prove his point.
This is all because Kevin has an unshakeable preexisting belief that the Fed can curb inflation only by causing a recession. Consequently, when inflation abates but there is no recession, Kevin concludes that the Fed action didn't affect inflation. That logically follows from the prior belief, but the prior belief may be wrong.