Breitbart Business Digest: When Reality Changes, Will the Fed Affect?

In one of the many made-up statements attributed to the British economist John Maynard Keynes, he said: “When the facts change, my opinion also changes. What are you doing sir?

As far as everyone is sure, Keynes never said those words. They seem to come from the 1970 appearance of the American economist Paul Samuelson on a television show. meet the press Where the topic of inflation is discussed.

Samuelson is the author of possibly the best-selling economics textbook of all time. Economics: A Preliminary Analysis. Samuelson’s book appeared in multiple editions in the years following its original publication in 1947, until its final version in 2009, when its author left his mortal shell. Over the years, Samuelson’s forecast of inflation, which is healthy for the U.S. economy, fell from five percent to three percent and eventually to two percent.

sa meet the pressSamuelson said that this change in the inflation target has caused some criticism. Specifically, the Associated Press published an article titled “Author Must Decide.” The economist claimed he had the right to change his analysis while updated information was available. “When things change, my mind changes. What are you doing?” said Samuelson.

That’s what happened to the Federal Reserve last month. Fed officials are unusually clear in their plans to approve a half-point rate hike. Unlike their predecessors, led by Fed chairmen like Paul Volcker or Alan Greenspan, current Fed officials consider it crucial to prepare the market for interest rate changes. The idea is to avoid surprises that can cause turmoil in financial markets.

Although Fed officials have officially stopped talking about “temporary” inflation, many still seem to believe in one way or another that inflation will go away on its own. In fact, many economists believe inflation rose to 8.5% in March. They expect some kind of “perfect disinflation” to come into effect, slightly lowering the inflation rate through a moderate Fed increase, minimal unemployment growth, and sustained growth more or less close to what officials see as the Fed’s long-term potential. A slight drop in April, where inflation rose just 0.3 percent last month, strongly supports their view.

The shock that changed the Fed’s mind came on Friday morning, June 10, just days before the Federal Open Market Committee (FOMC) began its meeting on Tuesday, June 14. The first is the Department of Labor report on the Consumer Price Index (CPI). It showed that prices rose 1 percent in April from April, excluding a 1.2 percent increase in March; This is the highest monthly inflation rate since the pandemic. On an annual basis, the index rose 8.6% above its misidentified March peak.

The second shock was the rise in inflation expectations in the consumer sentiment survey conducted by the University of Michigan. Survey results are published twice a month. The first will appear in the middle of the month and will be considered a preliminary reading. It happened before the FOMC meeting on Friday in June. It showed that inflation expectations for the coming year were slightly higher than in May and 5.4 percent, corresponding to March and April. Perhaps more troubling is that inflation is expected to jump from 3 percent to 3.3 percent over the next five to 10 years.

Inflation expectations play a large role in how Fed officials and internal economists think about inflation. They believe that future inflation expectations of households and businesses are an important determinant of actual inflation. Critics, including a Fed economist in an article published last year, say there is little evidence that inflation expectations play the causal role that major economists ascribe to them. But it remains the dominant paradigm in the Fed.

In the minutes of the FOMC meeting released Wednesday, “many respondents were concerned that long-term inflation expectations could begin to rise to levels inconsistent with the 2 percent target.” “These participants realized that if inflation expectations were not stabilized, it would be more costly to reduce inflation to the level set by the Committee.”

Fed officials decided that a 50 basis point increase would be insufficient as inflation data fell short of expectations. They quickly moved on to a 75 basis point increase and successfully reported this to the financial markets, following the “no surprises” rule. Minutes showed a noticeably strong consensus for a 0.75 percent move. Not only did 11 of the 12 FOMC members who voted agree with the substantial increase, each of the six members who did not vote agreed. Only Esther George of the Kansas City Fed disagreed, saying the Fed was moving too quickly.

Is George right? In the latest consumer confidence tally at the University of Michigan, long-term inflation expectations were revised to 3.1 percent, close to the 3 percent they had experienced in the months before jumping to the alarming 3.3. As a matter of fact, long-term inflation expectations were at 3.1 percent in January. The annual rate is expected to be revised down to 5.3 percent in May and below the March and April values.

Esther George, President and CEO of the Kansas City Federal Reserve Bank, speaks at the NABE annual meeting in Denver, Colorado, October 6, 2019. (via Daniel Brenner/Bloomberg, Getty Images)

Not only did consumers’ inflationary expectations change significantly. FOMC minutes have repeatedly spelled out the power of consumer spending. “During the household sector discussion, participants noted that consumption expenditures remained flexible, in part as a reflection of the strong balance in the household sector and a tight labor market,” the minutes said. But we now know that consumer spending is lower than they thought at that meeting. Instead of the first reported 3.1 percent growth rate, consumer spending rose just 1.8 percent in the first quarter. Consumer spending rose only 0.6% in April and 0.2% in May, remaining below inflation. Far from being “sustainable,” consumer spending is falling in real terms.

In other words, some of the information that went into the Fed’s change of mind in June turned out to be inaccurate. Of course, the Fed may not know this. Also, a larger Fed hike may turn out to be the right policy, even if it’s based on economic data that no longer matches the facts.

One question is whether the Fed can change its mind again as we have data showing a very rapid economic slowdown. Facts are still changing. Can monetary policy keep up with the times?