Yves here. This post provides a much-needed remedy to US inflation while the economy (for many) still looks pretty good. The Fed’s effectiveness may soon be tested with port strikes, which look set to last long enough to create supply chain pressures, and a simmering conflict in the Middle East that is pushing up oil prices.
By Thomas Ferguson, Research Director of the Institute for New Economic Thinking, Professor Emeritus, University of Massachusetts, Boston; and Servaas Storm, Senior Lecturer in Economics, Delft University of Technology. Originally published on
The biggest factor in calculating power in an economy is the continuing importance of the wealth effect in driving the consumption of the wealthy.
End of summer festivals have long been traditional high places in the world of art and music. These days, courtesy of the Federal Reserve Bank of Kansas City, central bankers are preparing their version of Bayreuth or Salzburg: a conference held in late August in Wyoming at Jackson Lake Lodge in Grand Teton National Park.
This year’s gathering focused on the effectiveness of monetary policy. In stark contrast to other previous conferences, the atmosphere was cheerful. The apparently relaxed bankers appeared to be celebrating inflation, which has fallen from a high of around 10% in early 2022 to below 3%. They were happy to take a few moments of victory, giving themselves an ultimately successful policy response to the sudden rise in inflation (Powell 2024). Their main source of pride seems to be centered on their ‘honest commitment’ to defeat inflation, which, in the official story, sent a signal to markets, firms and workers that the central banks will do “anything” to restore the price. stability.
In their contacts, it was this strong commitment that stopped the subsequent 1970s-style inflation, keeping inflation expectations ‘solid’, as central bankers like to say. As a result, they thought that inflation had fallen without causing a deep recession, which few mainstream economists predicted.
But how much debt is the Federal Reserve worth? Are significant macroeconomic fluctuations evidence of the Fed’s honesty, determination and wisdom? Or is it just luck that inflation has come down without a big rise in unemployment?
Our new INET Working Paper analyzes claims that the Fed is responsible for US inflation We compare several different measurement methods. This indicates that the majority of the Fed would want credit somewhere between twenty and forty percent of the decline.
This paper then examines the claims of central bankers and their supporters that the Fed’s strong commitment to maintaining inflation expectations has played a major role in this process. The paper shows that it did not. The Fed’s own research shows that low-income Americans do not believe assurances from the Fed or anyone else that inflation is contained. Even a recent study by the International Monetary Fund (see Gourinchas 2024) concludes that expectations were less important in determining recent inflation and subsequent inflation.
The US inflation rate is actually falling because global supply constraints are falling and food and energy prices are weakening over time. The appreciation of the dollar helped by lowering the cost of US dollar imports and by reducing the export demand for American goods. The Biden administration has also withdrawn stocks from the strategic fuel storage facility at critical moments and made appropriate efforts to resolve the crisis at the ports.
But the main factor in the decline is the simple fact that American workers, in general, have not been able to increase their statutory wages in line with the rising cost of living. Falling real wages have absorbed price-level shocks, unlike in the 1970s, when US workers (and unions) were still able to protect their real wages from inflation. We present clear evidence against popular claims, eg, by Autor et al. (2023), that the COVID or the arrival of the Biden administration brought about a radical change in the structure of the American labor market in favor of the least advantaged workers. If this were true.
Based on our analysis it is clear that the big banks are demanding credit for development that was beyond their control. The issue is bigger than their usual circumstances, because Jackson Hole’s self-aggrandizement of monetary policy warrants a new round of what John Kenneth Galbraith (1973) called “Practical Economists,” who support a broken macroeconomic model in which the ‘inflationary expectation channel’ plays a key role in price volatility. of wages. The celebration also distracts from the Fed’s continued failure to address, or even recognize, the key factors that are still fueling inflation, especially in services.
The paper then takes up the obvious question of why interest rate increases so far have not led to a significant increase in unemployment. We show that recent arguments by Benigno and Eggertson that changing vacancy rates can explain this are inconsistent with the evidence. Benigno and Eggertson (and many others) treat job opening data with no sense of their weaknesses. They ignore the false positions or their increased seismicity when the COVID has arrived. We think that vacancy data are worthless as evidence about the true state of labor markets.
The biggest factor in calculating power in an economy is the continuing importance of the wealth effect in driving the consumption of the wealthy. This arises, as we have emphasized in several previous papers (Ferguson and Storm 2023, 2024a, 2024b, 2024c), from the Fed’s rate reduction policies. Absent a sharp decline in wealth, the continued importance of the wealth effect is likely to feed inflation in the service sector in particular. Therefore, we think that there will be climate change and continued shocks from a mixed global economy. In the US, regulatory weakness in the face of tight currency politics is also likely to threaten price stability as demand for electricity rises from artificial intelligence firms and cryptocurrency mining.
References
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