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With Inflation Falling, The Fed Should Stop Trying to Cause a Recession [1]

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Date: 2022-11-15

Source: Bureau of Labor Statistics, accessed Nov 14, 2022 (https://data.bls.gov/timeseries/WPSFD4&output_view=pct_1mth)

In the 2nd half of 2022, inflation has been fairly tame. That’s been true of the Consumer Price Index (CPI), the price index for Personal Consumption Expenditures (PCE), and, as announced today, the Producer Price Index (PPI). Lower inflation is why long-term interest rates fell and the stock market soared last week when the October CPI was reported; today’s PPI report just confirms it.

So why is the Federal Reserve still raising short term interest rates so aggressively? Part of the answer is just a communications problem. Most media outlets report inflation over the last 12 months, which still includes the rapid price increases earlier this year. Such misreporting, in turn, led to this disastrously wrongheaded Washington Post editorial just before the Fed’s November 2 meeting: “To Beat Inflation the Fed Might Have to Trigger a Recession.

Here’s why I think the Fed is overreacting to inflation and risking an unnecessary recession:

First, Too Many Very Serious People in the Media are Building Narratives From Out of Date Figures, and This Constrains the Fed

Of course, the Fed doesn’t need to listen to the Washington Post, or any other financial publication. The Fed has the best financial economists in the worlds, so why would they feel pressured by ill-informed editorials and media speculation?

Because the media din creates a narrative, which, if the Fed did the economically appropriate thing — like halting rate increases for 4-6 months to see how the economy and inflation play out — it would be derided as “weak on inflation” or “political” or something. The Fed can’t have that, so they essentially have to play along with the dumb editorial narratives.

Second, The Fed’s Economists did Initially Understate Inflation, Even Before the Russian Invasion of Ukraine, and they don’t really know why, which leads them toward a “better safe than sorry” stance on inflation.

I believe the Fed initially understated post-Covid inflation, because they underestimated “monopolistic” or “me-too” price increases well in excess of the “cost plus” inflation that affected businesses. That is, the Fed (and many others) did not predict that so many companies would raise prices well in excess of the increases justified by their post-Covid supply costs.

This one is a bit tricky, so I’ll try to untangle it. All economists knew there would be some transitory “cost push” inflation as the economy bounced back from the Covid collapse. For example, shipping costs spiked as supply chains trying to restart, inventory problems were severe, etc.

But consumer prices seem to have been increased by many companies well in excess of these true underlying costs increases, mostly because companies learned they could get away with it. With supplies still at least partly constrained, they could raise prices without being undercut by competitors, because would-be competitors couldn’t get enough product to compete.

Conclusion. Hopefully the media will start to catch on that the most recent month’s inflation report shouldn’t be reported as the last 12 months’ worth of data, and the Fed will hit pause on raising short term interest rates at such rapid rates at their December meeting.

I fear we’re already entering a recession. But we need to spread the word that inflation is already coming down, and as competition ramps back up, the “me-too” price increases will start to fall too. The Fed should take a deep breath, ignore the pundits and editorial writers who don’t understand data very well, and see how this plays out for a while before we cause unnecessary economic hardship.

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[1] Url: https://www.dailykos.com/stories/2022/11/15/2136328/-With-Inflation-Falling-The-Fed-Should-Stop-Trying-to-Cause-a-Recession

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