I suppose it's pointless to keep repeating this since no one ever listens, but can we please stop this nonsense?
The Fed May Finally Be Winning the War on Inflation. But at What Cost?
[Neel] Kashkari insists...taming inflation must be the priority. “The sooner we take the medicine,” he says, “the less painful it will be.”
The medicine appears to be working — inflation is moderating, and some economists think that we have seen the worst of it.
The Fed is not winning anything and the patient hasn't been given any medicine yet. Nothing that's happened in the past year is related to Fed activity in any way. I assume that even the hard core forward guidance folks agree that six or seven months is far too short a time for the Fed's interest rate hikes to have affected the economy.
The Fed's war on inflation begins this summer, when its interest rate hikes and its public statements start to affect inflation. If inflation goes up over the next few months and then declines in the summer, the Fed will have proven itself farsighted. If inflation keeps going down and then the economy crashes midway through the year, the Fed will have proven itself about as competent as a Russian general. Wait and see.
Here's Paul Krugman weighing in:
Specifically, the Fed is trying to reduce inflation by slowing the economy, which it is doing in turn by raising interest rates. But there’s a raging debate over how much the economy needs to slow, how much rates need to rise to achieve a given amount of slowdown and how long rate hikes need to take full effect.
https://www.nytimes.com/2023/01/10/opinion/inflation-fed-recession.html
Emphasis mine. Krugman refers to a "raging debate" about the time lag associated with the effects of tightening. Kevin makes it sounds as if the question is settled. Maybe he's right. Or, perhaps there's more uncertainty about this issue that Kevin's adamancy suggests.
When we were mired in the Great Recession, Krugman argued that the Fed needed to convince people that it was going to be reliably irresponsible (keep rates essentially zero for some time) to convince people to spend. The argument now is for the Fed to be reliably responsible to convince people that more tightening is coming so they better cut down on spending. People plan ahead. How they view the Fed's likely actions in the future influences their behavior now.
+1
There's no doubt there is a lag; the "raging debate" is over how long the lag is.
There's no doubt there is a lag; the "raging debate" is over how long the lag is.
Kevin states nothing that's happened "in the past year" has been affected by Fed tightening. So, sure, there's a lag: I don't think anybody's suggesting the effects of Fed activity on the economy are literally felt instantaneously.
But the size of the lag will obviously have a bearing on whether Kevin is correct (we've yet to feel the effects of Fed tightening and all of it is still in our future) or he's wrong (we've been feeling the effects of said tightening for a while).
The difference between these two might translate into the difference between a soft landing (with the economy perhaps strengthening again as we head toward 2024) and a country that's mired in recession next year.
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Which is it?
"Nothing that's happened in the past year is related to Fed activity in any way."
"The Fed's war on inflation begins this summer, when its interest rate hikes and its public statements start to affect inflation."
Fed made public statements in 2022. Kevin doesn't say it affected inflation, but he says public statements in 2023 will.
These 2 quotes are not in conflict.
2022 Fed activity has not yet impacted inflation.
2022 Fed activity will begin to impact inflation over the summer, 4+ months from now.
IOW, even if you felt that inflation would come back down rapidly on its own, there was less risk of pushing the economy into recession (on account that the economy is incredibly strong) than the risk of anchoring high inflation expectations.
I think you are looking at the wrong paradigm. If the economy does not enter a recession, the Feds will have been accidentally/coincidentally successful at managing full employment and inflation. But critically, they will have restored the power of their favorite monetary tool in a recession: The Fed rate.
Always gotta destroy the village in order to save it.
And George Takei gets the last word,
https://twitter.com/GeorgeTakei/status/1613392899823083522
Hell hath no fury like a a pundit losing his cheap money.
I think Kevin has been overly optimistic for sure and I think his idea that the Fed rate increases have still had no effect on inflation is likely wrong. OTOH, team "OMG, it's the 70's again" are currently looking more off base than Team Transitory.
The framing is all wrong. Positing that a hot economy with solvable supply constraints is a disease that must be treated with medicine that will kill demand frames the situation in a way that makes it hard to argue against the medicine.
Like treating cancer with bleach or an infection with an amputation. Neither actually addresses the underlying problem and likely makes the situation worse....but framing it as common sense, 'gotta take your medicine' type of advice ignores that the medicine might not be appropriate and might harm the patient even if it takes care of the cancer or infection problem.
And again....
There are some immediate effects to the Fed raising rates:
1. mortgage payments go up.
2. other interest rates on some consumer loans/credit cards go up.
3. busted crypto bubble (though still has a way to go)
4. busted "irrational exuberance" in the stock market--too a point.
5. companies start taking fiscal discipline more seriously
The effect on the CPI will take awhile to show up in the numbers. Eventually housing prices will drop--though mortgage payments can still be the same or even keep going up a bit.
Unwinding the quantitative easing and getting rid of the "cheap money" instituted to keep the economy going during the pandemic down turn was certainly needed. Cranking it up to squeeze the life out of the economy is overkill--and you end up with the Fed creating business cycles as opposed to responding to them.
The problem with the "messaging" from the Fed is that they've locked themselves into rate hikes.
I heard that Japan is having problems with inflation too. Does that mean their ongoing problems with deflation has ended?
I don't think the Fed locks themselves into rate hikes by messaging, because they always have the option to depart from the foreshadowed policy changes as soon as conditions change. They wouldn't have done all those rate hikes in 2022 if inflation had only dropped off the way Team Transitory folks expected them to. Now that inflation does seem to be easing up (which was not so evident until December), presto! the Fed is saying the rate hikes in 2023 will be smaller. And they may not happen at all.
Expectations make a huge difference to the economy. You can see the slight tone of panic in the real estate ads. Everyone anticipates higher mortgage costs and eventually falling prices so buyers stop buying, builders stop building, and sellers can't sell. The housing sector is so big a little change makes a big difference to the economy.
You are wrong.
There is little doubt that the price of houses is significantly lower than they would have been if we had kept rates super low.
That means that people have not been able to get as many HELOCs which reduces demand on whatever they would have used the money for.
That lowers inflation.
Now, I agree that MOST of the effect of higher interest rates hasn't yet reduced inflation in many areas.
After all, inflation fell off a cliff at the end of June. I'm not sure anyone knows why. I've never seen such an abrupt drop but my job doesn't directly deal with understanding inflation.
But MOST of the time you shouldn't make absolute statements like this: "The Fed is not winning anything and the patient hasn't been given any medicine yet. Nothing that's happened in the past year is related to Fed activity in any way."
That is very true in this case, since you are almost certainly wrong.
> Nothing that's happened in the past year is related to Fed activity in any way. I assume that even the hard core forward guidance folks agree that six or seven months is far too short a time for the Fed's interest rate hikes to have affected the economy.
Except that the return on bonds increased, stock prices dropped, mortgage interest rates went up, housing prices went down, ... each of which is directly related to Fed activity.