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What About Inflation?
The Atlanta Federal Reserve Bank's GDP Now Model predicts Q320 GDP growth of 30%. The FED’s Open Market Committee revealed its expected path of short-term interest rates designed to let inflation run higher than its 2.0% target to make up for periods when it has run below 2.0%. In previous statements the Fed had noted that its 2% inflation goal was "symmetric," which hinted that it would like to see inflation above 2% as much as below 2%. That commitment is now explicit, with the Fed saying, it "will aim to achieve inflation moderately above 2% for some time, so that inflation averages 2% over time. “The Fed also made it clear that it will keep monetary policy loose for a prolonged period of time, saying it expects to maintain near zero short-term interest rates until (a) the employment situation is back to normal (with an unemployment rate around 4.0%) and (b) inflation is running at or above 2%. The Fed's favorite measure of inflation, the PCE deflator, has grown at a 1.5% annual rate in the past ten years. So, in theory, the Fed could let it grow at an annual rate of 2.5% for the next ten years and claim consistency. Because the Consumer Price Index typically grows faster than the PCE deflator, the CPI would increase at about a 2.75% annual rate.
Back in June, the median forecast among Fed policymakers was that PCE prices would rise 0.8% in 2020 (Q4/Q4), which already appears too low. The Fed's June forecasts for inflation in 2021 and 2022 also look too low, at 1.6% and 1.7%, respectively. The M2 measure of the money supply is up 23% in the past year, the fastest rate on record, and much above its growth rate after the first use of Quantitative Easing between 2008 and 2015.
Consumer spending has revived faster than production, with retail sales up 2.7% versus a year ago in July, while industrial production is down 8.2%. The gap is unprecedentedly generous government transfer payments, which, in the four months ending in July, were up 77% versus a year ago. If people can spend more without producing more, and the country is headed for increased inflation. But with the Fed willing to let inflation rise, short-term interest rates won’t change anytime soon, which will hold the entire yield curve down for the near- to medium-term.
If inflation outstrips the Fed's long run 2.0% target, will the Fed act to bring it back down or will it let it run? The Fed's "dot plot" shows that the current consensus among policymakers is that there will be no rate hikes at all this year, or in 2021, 2022, or 2023, which is consistent with its new economic forecast, which, although it shows an upwardly revised pace of recovery in late 2020 as a well as a faster drop in the unemployment rate, shows the jobless rate at 4.0% at the end of 2023 and inflation not exceeding 2.0% until at least 2024. The Fed doesn't think the economy will meet its two-pronged test for rate hikes (employment and inflation) until at least 2024. Furthermore, if the Fed wants to see inflation persistently exceeding 2.0% before it raises rates, it thinks rate hikes won't happen until the second half of the 2020s. The Fed has embarked on a what could be a dangerous strategy. History shows that in the late 1960s through the early 1980s, the FED rate rose above 10%. A 10x increase in interest rates with the present debt level would create an accelerating road to insolubility.
The Atlanta Federal Reserve Bank's GDP Now Model predicts Q320 GDP growth of 30%. The FED’s Open Market Committee revealed its expected path of short-term interest rates designed to let inflation run higher than its 2.0% target to make up for periods when it has run below 2.0%. In previous statements the Fed had noted that its 2% inflation goal was "symmetric," which hinted that it would like to see inflation above 2% as much as below 2%. That commitment is now explicit, with the Fed saying, it "will aim to achieve inflation moderately above 2% for some time, so that inflation averages 2% over time. “The Fed also made it clear that it will keep monetary policy loose for a prolonged period of time, saying it expects to maintain near zero short-term interest rates until (a) the employment situation is back to normal (with an unemployment rate around 4.0%) and (b) inflation is running at or above 2%. The Fed's favorite measure of inflation, the PCE deflator, has grown at a 1.5% annual rate in the past ten years. So, in theory, the Fed could let it grow at an annual rate of 2.5% for the next ten years and claim consistency. Because the Consumer Price Index typically grows faster than the PCE deflator, the CPI would increase at about a 2.75% annual rate.
Back in June, the median forecast among Fed policymakers was that PCE prices would rise 0.8% in 2020 (Q4/Q4), which already appears too low. The Fed's June forecasts for inflation in 2021 and 2022 also look too low, at 1.6% and 1.7%, respectively. The M2 measure of the money supply is up 23% in the past year, the fastest rate on record, and much above its growth rate after the first use of Quantitative Easing between 2008 and 2015.
Consumer spending has revived faster than production, with retail sales up 2.7% versus a year ago in July, while industrial production is down 8.2%. The gap is unprecedentedly generous government transfer payments, which, in the four months ending in July, were up 77% versus a year ago. If people can spend more without producing more, and the country is headed for increased inflation. But with the Fed willing to let inflation rise, short-term interest rates won’t change anytime soon, which will hold the entire yield curve down for the near- to medium-term.
If inflation outstrips the Fed's long run 2.0% target, will the Fed act to bring it back down or will it let it run? The Fed's "dot plot" shows that the current consensus among policymakers is that there will be no rate hikes at all this year, or in 2021, 2022, or 2023, which is consistent with its new economic forecast, which, although it shows an upwardly revised pace of recovery in late 2020 as a well as a faster drop in the unemployment rate, shows the jobless rate at 4.0% at the end of 2023 and inflation not exceeding 2.0% until at least 2024. The Fed doesn't think the economy will meet its two-pronged test for rate hikes (employment and inflation) until at least 2024. Furthermore, if the Fed wants to see inflation persistently exceeding 2.0% before it raises rates, it thinks rate hikes won't happen until the second half of the 2020s. The Fed has embarked on a what could be a dangerous strategy. History shows that in the late 1960s through the early 1980s, the FED rate rose above 10%. A 10x increase in interest rates with the present debt level would create an accelerating road to insolubility.
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