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The Federal Reserve’s recent pausing of interest-rates hikes opens America’s door to stagflation. Going into the Fed’s June policymaking meeting, analysts made a big deal about how the U.S. central bank over the past 14 months had implemented the sharpest rate increases in recent memory. But challenges to both growth and inflation have been much tougher now than during the 1990s, 2000s and 2010s.
COVID shutdowns imposed a lot more unemployment than the 2008 Global Financial Crisis, and instead of measuring contemporary Fed policies against those implemented when inflation was tamer, it’s more appropriate to compare Jerome Powell’s Fed to the 1980s Paul Volcker regime.
After the promiscuous tenures of Fed Chairmen Arthur Burns and William Miller and the pressures created by an aggressive OPEC oil cartel, year-on-year inflation jumped to 14.8% in March 1980. Then Chairman Volcker responded by pushing the federal funds rate to 19.1% by June 1981 — far-above peak inflation.
The U.S. economy suffered a tough recession as a result, but that cracked the back of inflation and set the table for the Reagan era of prosperity.
Now, in the wake of the pandemic and $4.6 trillion in federal relief and stimulus spending, which was enabled by the Powell Fed expanding its balance sheet to monetarize much of the resulting new debt, year-over-year inflation was 9.1% in June 2022. The Fed responded by raising the federal funds rates to 5.1% by May of this year — far-below peak inflation.
A rate-hike pause now with promises of two more quarter point interest rate increases in the future reflected the split among Fed policymakers between hawks and doves, rather than effective inflation-fighting polic. This decision gave everyone something they wanted, but no one came away happy.
Inflation nation
Powell puts a great deal of stock in consumer expectations, and rightly so. Consumers are also workers, business owners and investors. Where consumers anticipate inflation is headed influences the wages that workers demand and employers offer, in addition to the mortgage rates new homeowners feel comfortable paying. Inflation expectations also factor into mortgage-backed securities and investor perceptions of the prospective returns on high-tech growth stocks.
According to Powell, long-term inflation expectations remain well-anchored, but consumers, home buyers and investors negotiate and make decisions on how they see things now and a year hence. Further down the road, economic decisions can be revisited.
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Expectations as measured by the bond market — the difference between the yield on ordinary 1-year Treasurys and comparable inflation-adjusted Treasurys — have widely undershot recent inflation. Consumer surveys, in contrast, generally come closer to the mark. For example, The Conference Board survey of consumer attitudes pegs inflation over the next 12 months at 6%, while the University of Michigan survey forecasts 4.2%.
Those numbers are well-above the Fed’s 2% inflation target.
Four times a year, members of the Fed policymaking committee are asked for the short- and long-term forecasts for GDP growth, employment, inflation and the future path of the Fed funds rate. Suffice it to say their forecasts have consistently underestimated future inflation, but so have the ruminations of professional economists.
At their most recent meeting, Fed policymakers again adjusted upward their outlook for core inflation and future federal funds rates. Although home buyers, businesses and equity investors might want lower interest rates, those currently are not terribly high when measured against expected inflation.
As a result, home sales and prices are in a rebound, interest-rate-sensitive tech stocks are leading a stronger U.S. stock market, and wages, according to the Atlanta Fed, are rising at 6% annually.
“ Core inflation remains stubbornly high. ”
Meanwhile, core inflation remains stubbornly high. Economists are expecting some let up in core inflation from falling rents on apartments and what homeowners could get by leasing out their dwellings, but we have been hearing that for months.
Each month the Bureau of Labor Statistics surveys one-sixth of its panel of renters and homeowners — consequently falling rents take up to six months to have full impact on the CPI. In recent months, increases in the seasonally adjusted Zillow rental indexes have slowed but not gone negative. Whatever reprieve we get from the cost of shelter should be short-lived.
In the months ahead, we could see temporary dips in inflation thanks to rents, but over the next few years inflation in the range of 4% is likely. With U.S. economic growth running at less than 2%, that’s stagflation.
Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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