Somethings i don't get. While high inflation is bad, what is the calibration benchmark? Why does Fed keep touting the commitment on "2%" target? What's the merit/basis of this magical mark of 2%? Economy as a whole is highly complex and keeps changing all the time. So why does CBs stick to a particular mark of 2% all the time? If i am not mistaken, Stiglitz recently said that global economy has to undergo transformation (to address energy needs, climate change etc) and 4% might be a new normal during this intermediate period while we transform.
Also something about cost of living and demand. The Fed raises rates in a hope that it will re-calibrate demand and curtail spending on specific set of goods & services. But by raising rates, the other set of things can become costlier - interest payments of housing/auto/business loans etc. So basically cost of living or cost of doing business stays high or can become high. So while intended goal of CB is to cure inflation, it is burdening the consumer/labor/businesses with higher costs on different end. Like i have a pain in my leg, Doc gives me medicine that will cure my leg pain & transfer it to my arm!
Here in India, our CB is also raising interest rates and monthly interest payments on housing loans have become costlier by as much as 20%. There is some small decline in commodity inflation (which our CB likes to take credit for!) but ultimately the economy is now suffering from different ways as households/businesses become more burdened with higher payments on debt. So how does CB plays the balancing act?
Of course the fiscal policy and strategic planning on various fronts is the key. That should be our main focus.
I'll share this on Twitter later on, this is another solid piece here. With regards to fiscal policy, yes congress is going to have to do more (with a divided congress likely won't happen) but two things we can talk about that will help are the Federal Job Guarantee and also the Green New Deal. Botton line, indeed the federal reserve alone is doing its best to start a recession and that's just plain wrong.
The technology sector has been particularly affected by the interest rate hikes but with a strong labor market most of these people have been able to find new jobs. I believe there are reports that the pace of spending is decreasing, which will have cascade effects; I personally think the labor market will begin cooling in due time.
I'd love to know how you think about the lag effects of the interest rate hikes?
Great article. I see no reason to increase interest rates anymore. The housing market has been hit. And since previously the Fed was the buyers of mortgages and has stopped the spreads have blown out compared to other bonds. If the Fed thinks that hitting the housing market is going to affect construction they are sadly mistaken. The infrastructure bill and the inflation reduction act will take those workers. They did reduce employment in housing related areas. And don’t get me started on the auto market.
Not a bad effort. But since macro has no real theory of prices and inflation - other than the Phillips curve - and no one has read Phillips’ paper - the onus is on CBs to demonstrate any link between inflation and interest rates and it’s something they can’t do. Even on the demand side, there are those who would argue that inflation in the 80s would have come down if Volker has done precisely nothing.
This is nothing new, John Kenneth Galbraith said as much seventy years ago, “Monetary Policy is a very thin reed on which to lean”.
So you’ve taken a good fist step. The second is simply to accept that CBs have no useful tools to “manage” the economy - although their tools are powerful to manage/increase inequality. So let’s get back to using fiscal tools and relegate CBs to their proper job, regulating the financial sector.
And on that front, there’s lots to do. It starts with Warren Mosler’s argument for a zero-rate policy. Without interest bearing bonds, the financial sector’s house of cards would collapse and we’d all (well, the 99%) be better off for it. Mosler’s argument is that “money” is nothing more or less than a tax credit. If people want to save tax credits, all power to them, but to pay them to save them? There’s no reasonable argument we should do so. In fact, it’s madness.
As a closing statement, in opposition to Greenspan who said inflation is always a monetary phenomenon, I’d say it obviously can be but rarely is. It’s about the availability of real resources in the economy.
We’ve been led down a path of thinking that viewing the real world through a money lens is helpful. In fact it’s the opposite. It’s why people, today, are coming to believe that, “it’s easier to imagine the end of the world than the end of capitalism “.
What fiscal policy can do to reduce inflation is what it should be gong anyway. (immigration is always good and buying low and selling high from the SPR is what any speculator would do)
If fiscal policy were itself interest rate sensitive (as it should be) deficits would shrink as the fed rises rates. [Fewer expenditure and more tax increases would pass NPV tests.] This would be a better distribution of demand than what the Fed can do alone (hitting construction and investment) But I don't think saying the Fed CAN'T get inflation back on target alone is the best way of getting across this point.
The Conductor CAN direct the orchestra, but the results will not be good if the First Violin is not paying attention.
I appreciate the focus on the supply shocks. I think too many people assume that just subsiding supply issues will result in inflation returning. Lorenzoni and Werning, which I covered in a post last week, recently showed that supply side issue must fully dissipate for inflation to get back to previous levels. And not only do supply side issues have lagged effects feeding through the system, we have still significant supply issues right now - car market, equipment manufacturing, even bakeries. The New York Fed posted adjustments to inflation metrics today, which showed that goods inflation kept going up. Fiscal policy is needed to correct and strengthen the supply side in the long run, especially since such crises might keep re-appearing.
I recommend Stephanie Kelton’s The Deficit Myth to answer your questions. I’m listening to Peter Zeihan’s latest, The End of the World is just the Beginning and his strategic analysis remains very well done and his bleak outlook for the new era completely possible yet his understanding of fiat currency highlights why his bleak outlook supports. Using an MMT Lens, we have an incredible opportunity to shape this new era in a much more positive, moral and dynamic way. I plan to communicate with him and perhaps create an ongoing dialogue for strategic planning using fiat currency through fiscal policy execution to modify his current analysis. He really doesn’t know MMT correctly...
Just finished Bernanke's book '21st Century Monetary Policy'. He starts his history in late 1960s and goes throught he pandemic. What amazes me is that the first chapter focuses on the Phillips Curve 1970-1980, as the book progresses, there is very little mention of it. It is, in any case, an interesting take on the past 50 years, and more terrifying than I would have expected.
In general, when I read about the worries of stagflation from the 1970s returning, there is no mention of the ending of the gold window or the transition from gold to free floating exchange (in theory) and how that took time. Also, while Volker is held up high for fighting inflation, there is little to nothing about he actually pushed for dropping the gold window and communicated the plan to central banks around the world to transition to a bracketed exchange period.
This is more complex topic, how much did this change from gold (which was unsustainable) to free floating contribute to inflation and the ongoing monetary expansion? Does the removal of a gold standard make the monetarist theories more important or less important?
The recent PCE numbers would suggest that real interest rates are very low. So even if interest rates cannot solve supply-side issues, wouldn't very low real interest rates exacerbate inflation?
Seems to me that relying on reserve/central banks to manage inflation is convenient for governments - they don't have to do anything and have someone else to blame (eg, Philip Lowe at the RBA is getting a shellacking at the moment).
As a Political Economist, I also blame the mainstream economics discipline. It's a patriarchal monoculture, speaking with one voice and one theory. The real world is too complicated for that, and shutting down or marginalising alternative voices means that good ideas are not tested. All good ideas should be tested, at least at the theoretical level, and not just dismissed or ignored.
We need good ideas to be tested with rigorous debate, and the best implemented. More "business as usual" is just not good enough, and people are starting to see it.
“Financial markets had disagreed with the Fed on what future policy will likely be. Since the fall, markets disagreed even as the Fed raised rates and said it would keep them high. So, market conditions became less restrictive, making policy less effective.”
Gosh, I thought Neel Kashkari was going to “teach Wall Street a hard lesson.” A word of advice from James Caraville: “If there is such a thing as reincarnation, I want to come back as a bond vigilante.”
Supply and demand: There is ample supply of hubris on Wall Street and the Fed. More ego that effort is non-productive.
I do hope that Caraville comes back as a Japanese bond “vigilant”. In Japan, I believe they’re called “widow makers”. It’s because the Japanese CB has no tolerance for its financial sector ever since it led Japan to valuing an acre of Tokyo as more than the entire US. I exaggerate but...
Your analysis is well laid out and detailed as usual. BUT, as they say, "This is not rocket science!" Actually it IS politics - we have such a dysfunctional government - looking for traitors in the FBI, stolen votes, and eager to cut social security and not raise the debt ceiling - that fiscal and manufacturing policy, actually running the country, is out of the question. Thus the Fed is the only game in town. And like the carpenter with a hammer, everything looks like a nail. Let's hammer it!
Nice post.
Somethings i don't get. While high inflation is bad, what is the calibration benchmark? Why does Fed keep touting the commitment on "2%" target? What's the merit/basis of this magical mark of 2%? Economy as a whole is highly complex and keeps changing all the time. So why does CBs stick to a particular mark of 2% all the time? If i am not mistaken, Stiglitz recently said that global economy has to undergo transformation (to address energy needs, climate change etc) and 4% might be a new normal during this intermediate period while we transform.
Also something about cost of living and demand. The Fed raises rates in a hope that it will re-calibrate demand and curtail spending on specific set of goods & services. But by raising rates, the other set of things can become costlier - interest payments of housing/auto/business loans etc. So basically cost of living or cost of doing business stays high or can become high. So while intended goal of CB is to cure inflation, it is burdening the consumer/labor/businesses with higher costs on different end. Like i have a pain in my leg, Doc gives me medicine that will cure my leg pain & transfer it to my arm!
Here in India, our CB is also raising interest rates and monthly interest payments on housing loans have become costlier by as much as 20%. There is some small decline in commodity inflation (which our CB likes to take credit for!) but ultimately the economy is now suffering from different ways as households/businesses become more burdened with higher payments on debt. So how does CB plays the balancing act?
Of course the fiscal policy and strategic planning on various fronts is the key. That should be our main focus.
I'll share this on Twitter later on, this is another solid piece here. With regards to fiscal policy, yes congress is going to have to do more (with a divided congress likely won't happen) but two things we can talk about that will help are the Federal Job Guarantee and also the Green New Deal. Botton line, indeed the federal reserve alone is doing its best to start a recession and that's just plain wrong.
Awesome read. The right tool for the job is important. I have broken many a screwdriver using it to hammer nails.
Awesome article (as always)!
The technology sector has been particularly affected by the interest rate hikes but with a strong labor market most of these people have been able to find new jobs. I believe there are reports that the pace of spending is decreasing, which will have cascade effects; I personally think the labor market will begin cooling in due time.
I'd love to know how you think about the lag effects of the interest rate hikes?
Lags are a topic of great debate now. I should write a post about that. Great idea.
Can't wait to see it!!
Great article. I see no reason to increase interest rates anymore. The housing market has been hit. And since previously the Fed was the buyers of mortgages and has stopped the spreads have blown out compared to other bonds. If the Fed thinks that hitting the housing market is going to affect construction they are sadly mistaken. The infrastructure bill and the inflation reduction act will take those workers. They did reduce employment in housing related areas. And don’t get me started on the auto market.
Not a bad effort. But since macro has no real theory of prices and inflation - other than the Phillips curve - and no one has read Phillips’ paper - the onus is on CBs to demonstrate any link between inflation and interest rates and it’s something they can’t do. Even on the demand side, there are those who would argue that inflation in the 80s would have come down if Volker has done precisely nothing.
This is nothing new, John Kenneth Galbraith said as much seventy years ago, “Monetary Policy is a very thin reed on which to lean”.
So you’ve taken a good fist step. The second is simply to accept that CBs have no useful tools to “manage” the economy - although their tools are powerful to manage/increase inequality. So let’s get back to using fiscal tools and relegate CBs to their proper job, regulating the financial sector.
And on that front, there’s lots to do. It starts with Warren Mosler’s argument for a zero-rate policy. Without interest bearing bonds, the financial sector’s house of cards would collapse and we’d all (well, the 99%) be better off for it. Mosler’s argument is that “money” is nothing more or less than a tax credit. If people want to save tax credits, all power to them, but to pay them to save them? There’s no reasonable argument we should do so. In fact, it’s madness.
As a closing statement, in opposition to Greenspan who said inflation is always a monetary phenomenon, I’d say it obviously can be but rarely is. It’s about the availability of real resources in the economy.
We’ve been led down a path of thinking that viewing the real world through a money lens is helpful. In fact it’s the opposite. It’s why people, today, are coming to believe that, “it’s easier to imagine the end of the world than the end of capitalism “.
I agree with you wholeheartedly, but I think it was that other fool, Friedman, who said "inflation is always and everywhere a monetary phenomenon."
What fiscal policy can do to reduce inflation is what it should be gong anyway. (immigration is always good and buying low and selling high from the SPR is what any speculator would do)
If fiscal policy were itself interest rate sensitive (as it should be) deficits would shrink as the fed rises rates. [Fewer expenditure and more tax increases would pass NPV tests.] This would be a better distribution of demand than what the Fed can do alone (hitting construction and investment) But I don't think saying the Fed CAN'T get inflation back on target alone is the best way of getting across this point.
The Conductor CAN direct the orchestra, but the results will not be good if the First Violin is not paying attention.
I love music.
I appreciate the focus on the supply shocks. I think too many people assume that just subsiding supply issues will result in inflation returning. Lorenzoni and Werning, which I covered in a post last week, recently showed that supply side issue must fully dissipate for inflation to get back to previous levels. And not only do supply side issues have lagged effects feeding through the system, we have still significant supply issues right now - car market, equipment manufacturing, even bakeries. The New York Fed posted adjustments to inflation metrics today, which showed that goods inflation kept going up. Fiscal policy is needed to correct and strengthen the supply side in the long run, especially since such crises might keep re-appearing.
I recommend Stephanie Kelton’s The Deficit Myth to answer your questions. I’m listening to Peter Zeihan’s latest, The End of the World is just the Beginning and his strategic analysis remains very well done and his bleak outlook for the new era completely possible yet his understanding of fiat currency highlights why his bleak outlook supports. Using an MMT Lens, we have an incredible opportunity to shape this new era in a much more positive, moral and dynamic way. I plan to communicate with him and perhaps create an ongoing dialogue for strategic planning using fiat currency through fiscal policy execution to modify his current analysis. He really doesn’t know MMT correctly...
Just finished Bernanke's book '21st Century Monetary Policy'. He starts his history in late 1960s and goes throught he pandemic. What amazes me is that the first chapter focuses on the Phillips Curve 1970-1980, as the book progresses, there is very little mention of it. It is, in any case, an interesting take on the past 50 years, and more terrifying than I would have expected.
In general, when I read about the worries of stagflation from the 1970s returning, there is no mention of the ending of the gold window or the transition from gold to free floating exchange (in theory) and how that took time. Also, while Volker is held up high for fighting inflation, there is little to nothing about he actually pushed for dropping the gold window and communicated the plan to central banks around the world to transition to a bracketed exchange period.
This is more complex topic, how much did this change from gold (which was unsustainable) to free floating contribute to inflation and the ongoing monetary expansion? Does the removal of a gold standard make the monetarist theories more important or less important?
The recent PCE numbers would suggest that real interest rates are very low. So even if interest rates cannot solve supply-side issues, wouldn't very low real interest rates exacerbate inflation?
Seems to me that relying on reserve/central banks to manage inflation is convenient for governments - they don't have to do anything and have someone else to blame (eg, Philip Lowe at the RBA is getting a shellacking at the moment).
As a Political Economist, I also blame the mainstream economics discipline. It's a patriarchal monoculture, speaking with one voice and one theory. The real world is too complicated for that, and shutting down or marginalising alternative voices means that good ideas are not tested. All good ideas should be tested, at least at the theoretical level, and not just dismissed or ignored.
We need good ideas to be tested with rigorous debate, and the best implemented. More "business as usual" is just not good enough, and people are starting to see it.
I concur.
“Financial markets had disagreed with the Fed on what future policy will likely be. Since the fall, markets disagreed even as the Fed raised rates and said it would keep them high. So, market conditions became less restrictive, making policy less effective.”
Gosh, I thought Neel Kashkari was going to “teach Wall Street a hard lesson.” A word of advice from James Caraville: “If there is such a thing as reincarnation, I want to come back as a bond vigilante.”
Supply and demand: There is ample supply of hubris on Wall Street and the Fed. More ego that effort is non-productive.
I do hope that Caraville comes back as a Japanese bond “vigilant”. In Japan, I believe they’re called “widow makers”. It’s because the Japanese CB has no tolerance for its financial sector ever since it led Japan to valuing an acre of Tokyo as more than the entire US. I exaggerate but...
Thank you for your responses!
Sorry to be a pest today, but I have a related question: why do so few people talk about the Fed’s balance sheet? Is the topic to esoteric?
Your analysis is well laid out and detailed as usual. BUT, as they say, "This is not rocket science!" Actually it IS politics - we have such a dysfunctional government - looking for traitors in the FBI, stolen votes, and eager to cut social security and not raise the debt ceiling - that fiscal and manufacturing policy, actually running the country, is out of the question. Thus the Fed is the only game in town. And like the carpenter with a hammer, everything looks like a nail. Let's hammer it!
Claudia rocks! Excellent!