The Fed, the Bank of England and the European Central Bank all raised interest rates this week again to fresh multi-year highs.
They just can’t seem to help themselves.
At the same, they each suggested or explicitly warned that there is more tightening coming plus a willingness to hold their policies at hawkish levels for a while.
They just can’t seem to help themselves.
Let’s focus on the Fed. Inflation and all of its major drivers fell in the last half of 2022.
I’m not going to say it fell sharply, steeply or significantly, because some prices have come down – some even sharply, some just a tad – and some have not at all.
The so-called price deceleration occurred despite the pace of economic growth, which picked up in the second half of the year and unemployment remained fairly static.
We know that the goal of the Fed’s statutory dual mandate is to balance the risks of inflation versus the benefits of solid economic growth and maximum unemployment.
Jeremy Bivens points out that currently, “the benefits of low unemployment are enormous, and the risks of inflation are retreating rapidly.”
Here’s what he wrote before the Fed’s 25-basis point rate hike on Wednesday:
“If the Fed lets the current recovery continue [quickly] by not raising interest rates further at this week’s meeting, 2023 could turn out to be a great year for the economic fortunes of American families.
“It is time for the Fed to stand pat on interest rate increases and wait to see how the lagged effects of past increases enacted in 2022 will filter through to the economy.
“Continuing to raise rates in the early stretches of 2023 will be a clear mistake and pose an unneeded threat to growth in the next year.”
He envisioned a Powell press conference after a meeting at which the Fed decided to leave rates alone, emphasizing these points:
By Dave Allen for Discount Gold & Silver
The Fed, the Bank of England and the European Central Bank all raised interest rates this week again to fresh multi-year highs.
They just can’t seem to help themselves.
At the same, they each suggested or explicitly warned that there is more tightening coming plus a willingness to hold their policies at hawkish levels for a while.
They just can’t seem to help themselves.
Let’s focus on the Fed. Inflation and all of its major drivers fell in the last half of 2022.
I’m not going to say it fell sharply, steeply or significantly, because some prices have come down – some even sharply, some just a tad – and some have not at all.
The so-called price deceleration occurred despite the pace of economic growth, which picked up in the second half of the year and unemployment remained fairly static.
We know that the goal of the Fed’s statutory dual mandate is to balance the risks of inflation versus the benefits of solid economic growth and maximum unemployment.
Jeremy Bivens points out that currently, “the benefits of low unemployment are enormous, and the risks of inflation are retreating rapidly.”
Here’s what he wrote before the Fed’s 25-basis point rate hike on Wednesday:
“If the Fed lets the current recovery continue [quickly] by not raising interest rates further at this week’s meeting, 2023 could turn out to be a great year for the economic fortunes of American families.
“It is time for the Fed to stand pat on interest rate increases and wait to see how the lagged effects of past increases enacted in 2022 will filter through to the economy.
“Continuing to raise rates in the early stretches of 2023 will be a clear mistake and pose an unneeded threat to growth in the next year.”
He envisioned a Powell press conference after a meeting at which the Fed decided to leave rates alone, emphasizing these points:
· Rapidly falling inflation in the 4th quarter of 2022 even without falling housing inflation coming fast in 2023;
· Average wage growth of just 4.3% in the 4th quarter of 2022, down 30% from a peak of 6.1% earlier in the year – proving that wage growth can get back to normal without a ton of layoffs;
(Sorry, I don’t mean to minimize what’s already happened to thousands of workers who’ve lost their jobs or are finding it difficult to get another one.)
· With corporate profit margins likely moderating this year, labor’s share of income will rise, which has the potential to absorb any wage growth that exceeds its long-run targets for years to come.
Let’s look at wages – a primary concern of inflation hawks. Over the last year or so, they’ve worried that rapid growth in nominal wages (i.e., before the effects of inflation) would or could create a wage/price spiral.
But wage growth is slowing down and fast. The chart above shows the headline unemployment rate (sorry; see chart note above) and the 3-month change (shown as an annual rate) in wage growth since 2018.
Bivens points out that the dashed lines smooth out the extreme ups and downs of both unemployment and wage growth during the pandemic recession and early rebound.
Economists’ claim that 3.5% wage growth is the fastest rate consistent with 2% inflation “in equilibrium” assumes that the share of overall income claimed by workers’ pay rather than corporate profits remains constant.
However, Bivens says that wage growth can be higher than 3.5% “for a spell of time” while still being consistent with 2% inflation – if labor’s share of income rises.
He points out, however, that labor’s share of income has shrunk
Thus, “just returning to the pre-[pandemic] labor share of income would allow lots of wage growth without feeding through to price inflation.”
Conversely, he continues, this is like saying rising corporate profit margins have been a prime driver of inflation throughout this business cycle (that’s a point you’d never see coming from Wall Street).
But Bivens believes that profits “will stabilize or even contract in the coming year, [supporting] noninflationary wage growth.”
That is what’s happened in just about every single business cycle since World War II (almost 8 decades), when unemployment moved close to pre-recession levels late in recoveries.
In short, Bivens concludes that, on balance, the risks facing the Fed “has moved decisively away from spiraling inflation.”
Key sources of disinflation—especially housing costs and a rising labor share of income—have yet to kick in, and inflation still fell rapidly in the 4th quarter last year.
Thus, the Fed should hold off on future interest rate increases – at least for a few months – until we have more time to see how much more inflation comes down.
If, however, they insist on continuing to raise rates in March and beyond, it will, as Bivens concludes, “pose a dire threat to what could be an excellent 2023 for the economic prospects of America’s working families.”
Unfortunately, the Fed just can’t seem to help itself – or us!