News: The Fed’s moving target

Friday, June 3, 2022

The Fed’s moving target

Jun 03, 2022

By Victoria Guida and Aubree Eliza Weaver

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QUICK FIX

Adventures in inflation targeting — You might know the Federal Reserve's goal is for inflation to average 2 percent over time. Obviously that is not what we have (the personal consumption expenditures index increased 6.3 percent over the past year). But here's what might sound like an odd question: Does the Fed really want inflation to be 2 percent right now?

In a vacuum, the answer is, yes, of course. But in reality, getting inflation back down to 2 percent this year would almost certainly cause a recession. That's because price spikes are only this severe because of all sorts of production and shipping delays — from China's Covid lockdowns to Russia's invasion of Ukraine and more. The question is how much getting back to 2 percent is in the hands of the Fed, and how much is related to factors outside its control.

(If you look at the Fed's most recent projections — we'll get updated ones in a couple weeks — they project PCE to drop only to 4.3 percent by the end of this year.)

So, what's going on? You can think of inflation as being caused by some combination of demand (people are spending lots of money) and supply (goods aren't getting from point A to point B very fast). The Fed can only really address the demand side, as Fed Chair Jay Powell has pointed out. That means there's some amount of inflation that the Fed can't do anything about, and if it did, it would be damaging healthy levels of consumer spending.

That makes targeting 2 percent inflation a little bit more confusing, especially since it's pretty difficult to parse out how much inflation is caused by each half of the equation. The Fed seems to be hoping that the supply chain problems will ease quickly enough (over the next year or so) that this dilemma won't be too much of a problem. Or at least, that prices, such as on commodities, will stop rising, even if they stay high.

But if supply problems keep inflation elevated, that could pose communications problems for the Fed in the future, since the central bank has pivoted to a focus on the economy running too hot. Its current message: we've got this.

Bill Spriggs, a professor at Howard University and chief economist at the AFL-CIO, thinks the Fed risks overpromising on its ability to tame inflation, given the severity of supply problems.

"At the very beginning, the Fed had done an excellent job of setting people up to understand that the supply shocks were going to be very big and very intense," he said. "I don't understand why they didn't stick to their guns."

George Selgin, a senior fellow at the Cato Institute, similarly said the Fed shouldn't be overly fixated on 2 percent — particularly in the wake of a pure, severe supply shock in the form of Russia's invasion of Ukraine.

"There are good reasons for the Fed to allow the inflation rate to continue to be above target for some time," he said. "But if it's now convinced the public it's not going to do that, that's adding to the confusion."

Of course, the Fed definitely hasn't dropped its mentions of supply-side problems and their role in inflation. Powell has said success on inflation may depend on "events that are not under our control" and said outright that it's the demand side of the equation that the central bank can fix. But these questions are simpler to talk about than they are to truly measure.

"There's a lot of excess demand. There're more than 5 million more employed plus job openings than there are the size of the labor force. So there's an imbalance there that we have to do our work on," Powell said in May.

But if supply issues stay bad: "It would be a very difficult situation. I mean, we have to be sure that inflation expectations remain anchored. And I mean, that's part of our job, too, so we'd be watching that carefully. And it puts any central bank in a very difficult situation."

HAPPY JOBS DAY — And TGIF. Kate Davidson is back on Monday. Send tips to kdavidson@politico.com or @KateDavidson, or aweaver@politico.com or @aubreeeweaver. And reach me at vguida@politico.com.

STEP INSIDE THE WEST WING: What's really happening in West Wing offices? Find out who's up, who's down, and who really has the president's ear in our West Wing Playbook newsletter, the insider's guide to the Biden White House and Cabinet. For buzzy nuggets and details that you won't find anywhere else, subscribe today.

Driving The Day

BIDEN'S NEW MESSAGING BATTLE — Our Ben White and Kate Davidson: "President Joe Biden and the White House are trying to pull off a very difficult messaging pivot: Warn people the economy is about to slow down and convince them that it's a good thing.

"The message is not wrong, economists and Wall Street investors say. Slower job and wage growth could ease rapid inflation and take pressure off the Federal Reserve to jack up interest rates even faster. But it's not the easiest thing to explain to voters – who are already angry about inflation – as the midterm elections approach and Democrats fear getting swamped by Americans' dim outlook on the economy."

WHITE HOUSE FIXATED ON GAS PRICES — Our Adam Cancryn: "For the past several months, a White House-led team of economic specialists has marked each day in the same way: With a painstaking, state-by-state examination of gasoline prices and the intricate market forces pushing them relentlessly upward.

"Senior officials and others close to President Joe Biden view those prices as the cost that most directly affects voters' everyday lives, and therefore their perception of the economy as well. As such, Biden and his top advisers fixate on them with an intensity that some aides describe as obsessive. White House chief of staff Ron Klain has grown particularly absorbed by the issue, checking the average price of a gallon of gas every morning. He's lamented that it's the one item everyone knows the cost of because gas station billboards are so ubiquitous throughout the country."

SEC LEGAL DECISIONS CALL ENFORCEMENT POWER INTO QUESTION — Our Katy O'Donnell: "A pair of recent legal decisions aimed at the SEC could threaten the ability of all federal agencies to implement and enforce laws outside of a formal court.

"The 5th Circuit Court of Appeals last month ruled that the SEC violated a defendant's constitutional right to a jury trial through its use of an in-house court to try a case. The ruling came the same week the Supreme Court said it would take up a separate case about whether a federal court has jurisdiction to hear a challenge to an ongoing SEC administrative proceeding."

GOLDMAN EXEC WARNS OF ECONOMIC SHOCKS — Bloomberg's Sridhar Natarajan: "A top Goldman Sachs Group Inc. executive echoed Jamie Dimon's pessimistic tone, warning of tougher times ahead amid a string of shocks rattling the global economy. 'This is among — if not the most — complex, dynamic environments I've ever seen in my career,' Goldman President John Waldron said at an investor conference Thursday. 'The confluence of the number of shocks to the system to me is unprecedented.'"

NEW YORK FED OFFICIAL: DIGITAL MONEY COULD AFFECT BANK OPERATIONS — WSJ's Michael S. Derby: "The Federal Reserve Bank of New York official responsible for managing the central bank's balance sheet says private digital money could have notable effects on how monetary policy is implemented and could lead to greater variability in the size of central bank balance sheets.

"Speaking Thursday, Lorie Logan, who is currently the manager of the Fed's $9 trillion System Open Market Account and will become this summer president of the Dallas Fed, took stock of how things like cryptocurrencies, including stablecoins and central bank digital money, might impact how central banks make monetary policy."

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Fly Around

WH RAPID RESPONSE DIRECTOR HEADS TO TREASURY — CNN's Phil Mattingly: "President Joe Biden's director of rapid response will soon depart the White House for the Treasury Department, becoming the latest West Wing aide to shift to a more senior role in another part of the administration.

"Mike Gwin, an Ohio native who would inevitably end up in a key communications role in whatever the crisis or major policy issue facing Biden throughout the course of his first 16 months in office, will serve as the deputy assistant secretary for public affairs under Treasury Secretary Janet Yellen."

SPACS WERE ALL THE RAGE. NOW, NOT SO MUCH. — NYT's Matthew Goldstein: "Wall Street's love affair with SPACs is sputtering. After two hot and heavy years, during which investors poured $250 billion into SPACs, rising inflation, interest rate increases and the threat of a recession are fomenting doubts. Increasingly, investors are withdrawing their money from SPACs, which they're allowed to do at the time of the merger. With stocks of high-growth companies recently getting clobbered, they have been less willing to bet that SPAC mergers — which often involve risky companies — will be successful.

"At the same time, regulators are stepping up scrutiny of SPACs. The Securities and Exchange Commission has opened dozens of investigations into SPACs and is proposing tighter rules. Increased regulation would make SPAC deals less profitable for the big investment banks that arrange these transactions, because they would have to commit more resources to comply. They, too, have begun pulling back."

FED'S BRAINARD SAYS CASE FOR SEPTEMBER RATE PAUSE IS 'VERY HARD' — Bloomberg's Craig Torres and Catarina Saraiva: "Federal Reserve Vice Chair Lael Brainard said expectations for half-percentage-point increases in interest rates this month and next were reasonable, and saw no case for pausing the central bank's tightening campaign afterward. 'From where I sit today, market pricing for 50 basis points, potentially in June and July, from the data we have in hand today, seems like a reasonable path,' Brainard said Thursday in an interview with CNBC. 'Right now it's very hard to see the case for a pause. We've still got a lot of work to do to get inflation down to our 2 percent target.'"

Mester agreed that more rate hikes are ahead — Reuters: "The Federal Reserve needs to raise rates by a half-of-a-percentage point at each of its next two meetings, and then assess if inflation has moderated enough to slow the pace of rate hikes or if it needs to jack them up further, Cleveland Federal Reserve Bank President Loretta Mester said on Thursday. And while that process could be 'painful' for households and businesses, she said, it would be worse to allow inflation — now running at a 40-year high and more than three times the Fed's 2 percent goal — to continue to sap buying power and undermine economic momentum."

WHY A NOT-SO-HOT ECONOMY MIGHT BE GOOD NEWS — NYT's Ben Casselman: "When it comes to the economy, more is usually better. Bigger job gains, faster wage growth and more consumer spending are all, in normal times, signs of a healthy economy. Growth might not be sufficient to ensure widespread prosperity, but it is necessary — making any loss of momentum a worrying sign that the economy could be losing steam or, worse, headed into a recession.

"But these are not normal times. With nearly twice as many open jobs as available workers and companies struggling to meet record demand, many economists and policymakers argue that what the economy needs right now is not more, but less — less hiring, less wage growth and above all less inflation, which is running at its fastest pace in four decades."

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