Fed Complacency Feeds Inflation

The central bank’s strategy is meant to help lower-income earners, but rising prices hit them hardest.

By Mickey D. Levy. He is senior economist at Berenberg Capital Markets. Excerpts:

"Things haven’t worked out as the Fed intended. Inflation has run far above the Fed’s forecasts, well before its employment objective has been reached. Labor markets are showing stresses, and rising expectations of inflation now threaten to reinforce the trends of higher wages and inflation and harm economic performance.

It is ironic that high inflation, combined with the Fed’s zero rates and asset purchases, benefits the better off and harms lower-income earners—the people the Fed’s strategy intended to help. Prices of housing, food and energy, three of the highest-cost items for lower-income earners, are accelerating sharply. Energy and food prices are beyond the Fed’s control, but housing costs are directly linked to monetary policy. Lower-income earners tend to be renters, who face sharply higher rental costs, while higher-income households tend to be homeowners, who benefit from soaring home values. Zillow’s rental-cost index has risen 12.8% in the past year, and the S&P CoreLogic Case-Shiller home-price index is up 19.9%."

"the higher inflation wouldn’t have occurred without a strong recovery in demand. They had their pandemic collapse in the second quarter of 2020, and their recovery from that was the fastest rise in history. The Fed attributes that recovery to pent-up demand, while it understates the role that monetary policy plays in the economy. Unprecedented deficit spending has joined the Fed’s interest rates and massive asset purchases to fuel the boom in aggregate demand."

"Market-based expectations of inflation over the next five years have risen to 2.9%, while survey-based measures put expectations closer to 4%."

"In August there were 10.4 million job openings and 6.2 million new hires. The gap represents nearly the entire shortfall of current employment from pre-pandemic levels. Employment will rise to close the gap, and wages will accelerate. Businesses are basing their pricing decisions on expectations of persistently elevated inflation."