“Inflation Is A Hideous Monster. On The One Hand We Must Stamp It Underfoot. On The Other Hand, Not So Fast.” [1]
Federal Reserve board chairman Jay Powell has decided to douse the flames of inflation with a water pistol. His opening shot: a tiny increase in interest rates in an economy clearly capable of withstanding a more vigorous effort to rein in price increases.
The economy added an impressive 678,000 jobs in February, 654,000 in the private sector. The unemployment rate edged down to 3.8 percent, down 0.2 percent and within hailing distance of the pre-pandemic 3.4 percent. There are 11 million job openings, and consumers are sitting on $2 trillion in excess savings. Omicron is under control, witness the bravely maskless, risk-averse politicians attending President Biden’s State of The Union Address.
Ten days hence, when the Fed’s monetary policy team holds its March meeting, Powell will formally impose the one-quarter of one percentage point interest rate increase he advised congress last week would be one in “a series”. That will leave real, inflation-adjusted interest rates in negative territory.
Fed: Too Little, Too Late
The Fed is already behind the curve. Inflation, running at 6.1 percent as the Fed measures it, close to 8 percent as consumers experience it in their supermarkets, is more than a bit above the under-two percent the Fed was forecasting less than six months ago. All signs suggest that it won’t be too long before the Fed is forced to tighten faster and by more than Powell’s initial effort. Here's why.
Biden, Opec and War Drive Up Oil Prices
It is more rather than less likely that oil prices, well over $100 per barrel, will add to inflationary pressures, as OPEC’s Saudi Arabia and the United Arab Emirates continue to pander to the cartel’s Russian partner by refusing to open the valves on their substantial spare capacity. It is more rather than less likely that the President will continue to rein in the development of domestic oil and gas resources and refuse to allow completion of the Keystone XL pipeline that would bring 830,000 barrels per day of oil down from Canada, more than offsetting the 600,000 barrels per day now bought from Russia.
Soaring prices at the gas pump are regarded by incumbent politicians as a ticket to the private sector. That fact of political life prompted Biden to order 30 million barrels of crude oil released from the Strategic Petroleum Reserve “to blunt gas prices here at home.” That misuse of a reserve intended to cope with physical shortages covers about two-to-three days of US consumption.
More Missing Links On Supply Chains
It is more rather than less likely that the disruption of supply chains resulting from the war on Ukraine – hundreds of vessels trapped in ports and freight rates rising – will add to inflationary pressures. It is more rather than less likely that the tight labor market will add to upward pressure on wages, exacerbated by workers desperate to offset the inflation that is overwhelming the value of their pay raises. It is more rather than less likely that house prices will continue to rise, dragging rents up along with them. It is more rather than less likely that removal of Russia from wheat, barley, timber, palladium (used by automakers in catalytic converters), aluminum and other markets will continue to push up prices of those products. Ukraine is also an important producer of wheat that will not find its way to world markets: no surprise that wheat prices are already up more than 30 per cent.
Powell says the situation in Ukraine adds uncertainty to the economic outlook. True. But as Loretta Mester, president of the Federal Reserve Bank of Cleveland puts it “adds upside risk that high inflation might continue … increases the risk of inflation becoming embedded in the US”. Developments in Ukraine certainly do not portend an easing of inflationary pressures.
Biden Hopes To Pour Cash Into An Inflating Economy
Which brings us to fiscal policy. It is more rather than less likely that if the President gets what he wants, upward pressure on prices will intensify. In his State of the Union address Biden called for legislation to raise the federal minimum wage, and to make it easier for trade unions to organize the nation’s factories and drive up costs. He would like to raise corporate taxes, a burden that will flow, at least in part, through to prices. He plans to shield American firms from price-constraining foreign competition by divorcing America from the global economy to an extent not seen since protectionists seized control of American economic policy a century ago.
As if raising costs were not bad enough, the President would also boost demand in an economy already unable to supply the goods consumers want to buy. Pay of health care workers is to go up, and cash flow to consumers is to be increased by, among other things, providing child tax credits to millions of American families. It would be unkind to attribute this mash-up of a policy to Biden’s age; coherence has never been a hallmark of his political positions.
In short, we have a timid Fed managing monetary policy, and an administration eager to increase entitlement spending. Unless Powell trades his water pistol for a fire hose, the inflation genie need not fear being forced back into his or her bottle.
[1] Adapted from Finley Peter Dunne’s fictional Mr. Dooley, circa 1900, describing antitrust policy.