The Federal Reserve holds a symposium in Jackson Hole, Wyoming every year. It’s a rite of passage for many in central banking, monetary economics and Fed-watching.
Sometimes there is a key Fed policy reveal from the meeting, though not always.
This year, with a lot on the Fed’s plate, it’s likely Fed Chairman Jerome Powell will address the star-studded ensemble on Friday about the predicament facing monetary policy and what the Fed plans to do next. If the US wants to be a monetary policy leader, here is an opportunity to lead.
I have a recommendation to the president. It’s really quite simple. There are two extremely obvious things going on that have confused people about Fed policy. They are: 1. How will inflation fall as quickly as the Fed assumes, even before raising interest rates only around the neutral level? 2. How did the Fed choose the level to which it believes inflation will fall on its own before monetary policy has to do the rest of the work?
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In 2021, when inflation started to rise, the Federal Reserve first took the position that the rise in inflation was temporary and therefore the central bank did nothing to address it. The Fed is no longer in that very complex. However, the Fed appears to be in a relative rut that sees inflation falling while raising interest rates, even though interest rates are well below the rate of inflation. In the past, the Fed had to raise the federal funds rate above the rate of inflation to control it. The Fed needs to explain this.
The goals of the Fed
In this context, the Federal Reserve compiles forecasts for a number of economic variables and for the federal funds rate. We can see the central ranges for these predictions and, within them, see the midpoints. We can then use this as a rough guide to what Fed policy sees and then expects to do.
The Fed currently has these forecasts for year-end results for 2022, 2023 and 2024. And in these forecasts, the Fed focuses on the PCE deflator, not the CPI, a gauge for which inflation has become even crazier than in this PCE.
In June, PCE inflation rose 6.8% year over year, while core PCE inflation rose 4.8%. With these, the Fed is looking for the fed funds rate to end 2022 at around 3.35%, 2023 at 3.85% and 2024 at 3.25%. These levels are below the current rate of inflation.
The Fed sees core PCE at 4.4% at the end of 2022, 2.65% at the end of 2023 and 2.25% at the end of 2024. Using the midpoint of the central tendency range of Fed members’ estimates, the measurements give us a real Fed Funds rate of -1.8% by the end of 2022, 1.15% by the end of 2023 and -0.35% by the end of 2024. Specifically in 2022, with inflation currently at 6.8%, the Fed sees PCE inflation at 4.4% by the end of the year, even though the Fed Funds rate only rises to 3.35% at the end of the year. I think the Fed should tell us why this is going to happen.
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Far from attacking inflation with ultra-high interest rates as Paul Volcker did in the late 1970s and early 1980s, this Fed sees inflation breaking out on its own, with the sole task of pushing the Fed Funds rate at a moderately restrictive level to end. work.
The public is seeing a CPI inflation rate that has topped 9%, a Fed Funds rate (currently) at 2.5%, and bond markets are already buzzing about a Fed “pivot” to harmful conditions. What is this; On what planet would any sane, experienced bond market investor believe the Fed would stop raising interest rates at 2.5% with inflation this high? I can’t answer that. But it seems almost as implausible to wonder why the Fed plans to raise only the fed funds rate up to 3.85% or 4% as a terminal rate.
Fed credibility is key
The Fed needs to tell us clearly what is going on here. And it hasn’t. This may be because inflation expectations are so low. The University of Michigan, measuring inflation expectations five years ahead, sees CPI inflation at 4%, according to its mean, and 3% according to the median.
That may be a sign of confidence in the Fed — or not. The reason I doubt it is that the markets may be looking for the Fed to create a recession. The Fed has a lot of explaining to do to convince us one way or the other. It’s much more than just having credibility in the markets — it has to have a workable plan.
But reliability is one of the keys. To have credibility, the Fed must be willing to face the risks, the possibility of failure. And, so far, the Fed has been feeding us mostly a “have your cake and eat it too” approach, as Powell insists there’s still a way for the economy to soft land.
Increasingly, voices in the markets are wary of such a path and are warning of a recession. Will the Fed confront this issue head on or not? And will he make it to Jackson Hole or just do a hike?
Robert Brusca is chief economist at FAO Economics.