The Federal Reserve holds a symposium in Jackson Hole, Wyoming, every year. It’s a rite of passage for many central banks, the monetary economy and Fed watchers.
There is sometimes an important revelation of Fed policy at the meeting, though not always.
This year, with much on the Fed’s plate, it is very possible that Fed Chair Jerome Powell on Friday will speak to the star-studded group about the difficult situation facing monetary policy and what the Fed plans to do. If the US wants to be a leader in monetary policy, here’s a chance to lead.
I have a recommendation for the president. It’s really very simple. There are two extremely obvious things going on that confuse people about Fed policy. They are: 1. How will inflation fall as quickly as the Fed assumes, even before it has raised interest rates just to 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?
To read: Financial markets are bracing for what could be a ‘very hawkish’ Jackson Hole speech by the Fed’s Powell
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 counteract it. The Fed is no longer exactly in that movement. But the Fed appears to be on a related move that sees inflation falling while raising rates, even though interest rates are well below the rate of inflation. In the past, the Fed has had to raise the federal funds rate above the rate of inflation to control it. The Fed needs to explain this.
The Fed’s Targets
In this framework, the Federal Reserve gathers forecasts for a number of economic variables and for the federal funds rate. We can look at the central ranges of these predictions and, within them, see the midpoints. So we can use that as a rough guide to what Fed policy sees and hopes to do.
The Fed currently has these projections for year-end results for 2022, 2023 and 2024. And in these projections, the Fed focuses on the PCE deflator, not the CPI, an indicator for which inflation was even crazier than this PCE. .
In June, PCE inflation rose 6.8% year-on-year, while core PCE inflation rose 4.8%. With that, the Fed expects the federal funds rate to end 2022 at around 3.35%, 2023 at 3.85% and 2024 at 3.25%. These levels are below the current inflation rate.
The Fed sees the core PCE at 4.4% at the end of 2022, 2.65% at the end of 2023 and at 2.25% at the end of 2024. Using the middle of the central tendency range of Fed members’ estimates, metrics give us an actual federal 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. Notably in 2022, with the inflation currently at 6.8%, the Fed sees PCE inflation at 4.4% by the end of the year, although the federal funds rate will only be up to 3.35% at the end of the year. I think the Fed needs to tell us why this is going to happen.
To see: These dividend stocks can protect you as the Federal Reserve slows the economy
Far from attacking inflation with super-high interest rates, as Paul Volcker did in the late 1970s and early 1980s, this Fed sees inflation falling on its own, with the sole task of raising the federal funds rate to a moderately restrictive level to finish. the job.
The public sees a CPI inflation rate topping 9%, a federal funds rate (currently) at 2.5%, and securities markets already buzzing about a Fed “pivot” to dovish conditions. What is it? On what planet would any sensible and savvy securities market investor think the Fed would stop raising rates by 2.5% with inflation so high? I can’t answer that. But it seems almost as incredulous to ask why the Fed is only planning to raise the federal funds rate to 3.85% or 4% as a terminal rate.
The Fed’s credibility is key
The Fed needs to tell us clearly what’s going on here. And do not have. This could be because inflation expectations are too low. Reading the University of Michigan’s inflation expectations for five years ahead sees CPI inflation at 4%, according to its average, and at 3%, according to the median.
This could be a sign of confidence in the Fed – or not. The reason I’m wrong is that markets may be waiting for the Fed to create a recession. The Fed has a lot to explain to convince us one way or another. It is much more than just having credibility with the markets – it must have a workable plan.
But credibility is one of the keys. To be credible, the Fed has to be willing to face the risks, the potential to fail. And so far, the Fed has mostly fed us the “eat your cake and eat it too” approach, as Powell insists there is still a way to go for a soft landing for the economy.
Increasingly, voices in the markets are wary of the existence of such a path and are warning of recession. Will the Fed face this issue head on or not? And are you going to do it in Jackson Hole or just take a hike?
Robert Brusca is chief economist at FAO Economics.