Fed Chair Powell’s comments during his recent Q&A (after raising the Fed Funds target range rate by +50 bps to 4.25% to 4.5%) were quite sobering to anyone willing to listen. During his speech, he repeatedly reiterated his determination to lower the PCE inflation rate to 2% from its current level of 6% come hell or high water.
|Powell is Right, Inflation is a Pernicious Evil |
“The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislature. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her saving in a 5% passbook account whether she pays 100% income tax on her interest income during a period of zero inflation, or pays no income taxes during years of 5% inflation. Either way, she is ‘taxed’ in a manner that leaves her no real income whatsoever. Any money she spends comes right out of capital. She would find outrageous a 120% income tax, but doesn’t seem to notice that 5% inflation is the economic equivalent.”- Warren Buffett
While this rate hike slowed to +50 bps from the previous +75 bps level, Powell emphasized that we should expect a sustained time of restrictive monetary policy once the Fed reaches its Fed Funds target of 5.1% at the end of 2023, suggesting that it will only decline to 4.1% at the end of 2024 and 3.1% at the end of 2025. This is what he believes it will take to lower the Fed’s forecast for PCE inflation to 5.6% at the end of 2022, 3.1% in 2023, 2.5% in 2024, and finally to the 2.1% target in 2025.
However, as this chart reveals, the Fed in days past was willing to simply settle for a Fed Funds rate that was higher than the PCE (something that could be accomplished very soon). Even this sensible rule was violated after the 2008 Great Recession when the Fed Funds rate was held at zero for many years, including after Powell’s appointment to the board in 2012.
No matter, we are currently looking at 3 years of pain (possibly severe) to fix a covid lockdown that the Fed should have resisted to begin with. Further, Powell made it clear that his sympathies are not with the unemployed so much because the economic hurt from inflation is much worse. Maybe, but maybe it is also true that his power to make this decision is too much to wield for an unelected mortal.