• Breaking News

    DISCUSSION OF POLITICS AND ECONOMICS WITH FORAYS INTO PHOTOGRAPHY AND ASTRONOMY

    Search This Blog

    Friday, June 16, 2017

    Regional President Says Federal Reserve Is Still Fighting Inflation Wars Of 1970s

    Yesterday, I wrote about the unfathomable decision by the Federal Reserve to raise interest rates in the face of declining job growth, declining hourly wages, and declining inflation which is already low by historical standards. The only economic data that would even suggest the need for a rate hike is the unusually low unemployment rate, much of which is apparently driven by an exodus from the labor force rather than a huge growth in the numbers employed.

    Today, Neel Kashkari, the sole dissenter in the vote to raise rates, outlined the rationale for his opposition. According to Kashkari, "For me, deciding whether to raise rates or hold steady came down to a tension between faith and data." Faith relies on the belief, technically defined by something called the Phillips curve, that a tight labor market will lead to higher wages which forces businesses to pass on those increased labor costs to consumers in the form of higher prices which produces inflation.

    The data, however, belies the applicability of the Phillips curve at this moment. Not only does Kashkari point out that the data shows inflation is actually declining but also that the Fed has been predicting, erroneously, that inflation will rise above its 2% target for the last eight years.

    Kashkari takes the approach of a risk manager and sees the downside risks of raising rates too soon far outweigh the largely minimal consequences of waiting a short period and even allowing inflation to rise slightly above the 2% target. Right now, even Kashkari admits, many people view the 2% as a ceiling when it is simply a target. If the Fed is wrong that this current drop in inflation is not temporary, this rate hike will make it even harder to raise inflation and perhaps slow down job, wage, and economic growth even faster.

    But Kashkari's most revealing statement is that the Fed is still fighting a war that ended 40 years ago, saying, "The outcome that the current FOMC is so focused on avoiding, high inflation of the 1970s, may actually be leading us to repeat some of the same mistakes the FOMC made in the 1970s: a faith-based belief in the Phillips curve and an underappreciation of the role of expectations". In the 1970s, the Fed's belief in the Phillips curve and the weak economic data in terms of job and real GDP growth caused by that period of stagflation led them to actually cut rates twice as the inflation rate soared. Kashkari continues, "Today, that same faith may be leading the Committee to repeatedly (and erroneously) forecast increasing inflation, resulting in us raising rates too quickly and continuing to undershoot our inflation targets".

    The global and domestic economies have radically changed since the 1970s. But that doesn't seem to keep the generals at the Federal Reserve from fighting that last war. As Europe found out in World War II or America discovered in Vietnam, that approach never ends well.

    No comments:

    Post a Comment