The Fed is declaring war on inflation. It could lead straight to recession.

“many Fed watchers say some of the root causes of inflation lie outside the central bank’s control, like the U.S. labor shortage, global supply chain snags and Russia’s war on Ukraine. They’re raising concern that higher rates could crimp growth without leading to much relief on prices — a point that Sen. Elizabeth Warren (D-Mass.) has hammered away at Powell for months.”

“Markets are expecting rates to rise nearly 2 more percentage points by the end of the year. That would bring them to a level that is more normal by historical standards — the Fed’s main borrowing rate would sit above 4 percent — but is staggeringly high compared to the near-zero rates that have mostly prevailed for more than a decade.”

China targets Fed to gain influence, senator charges, drawing Powell rebuke

“China has recruited Federal Reserve economists for more than a decade to share sensitive and confidential information about U.S. economic policymaking in a bid to gain influence over the central bank, a Senate Republican charged in a report Tuesday.

The report from Sen. Rob Portman of Ohio, the top GOP lawmaker on the Homeland Security committee, detailed what Senate investigators called “long-running and brazen actions by Chinese officials and certain Federal Reserve employees” to replicate the playbook China has used to infiltrate the science and technology sectors. It involves recruiting industry experts to provide proprietary information or research in exchange for monetary benefits or other incentives, it said.

The Fed has failed to effectively combat the threat and doesn’t have sufficient expertise in counterintelligence or adequate policies to thwart China’s influence campaign, which includes efforts to obtain information about interest-rate decisions, the report concluded. It calls on Congress to enact bipartisan legislation that would enhance security around federally funded research, among other measures.”

How the Fed ended the last great American inflation — and how much it hurt

“In 1981, the US was in the midst of a second brutal stint of double-digit inflation in less than a decade. Gas prices were through the roof; mortgage rates were sky-high, keeping many middle-class people from being able to buy homes. The job market was weak, too, with unemployment above 7 percent. The nation was in full crisis.
The crisis would end, and most economists give credit for ending it to Paul Volcker, the chair of the Federal Reserve. Volcker got inflation under control through the economic equivalent of chemotherapy: He engineered two massive, but brief, recessions, to slash spending and force inflation down. By the end of the 1980s, inflation was ebbing and the economy was booming.

The 2022 inflation is not as bad as the inflation of 1978-1982 — but it’s the worst inflation the US has experienced in decades. The Federal Reserve is, accordingly, raising interest rates aggressively, as Volcker did. It’s not trying to engineer a recession, but its actions could cause one as an unintended consequence. And if inflation continues to be a major problem, demands for an even more aggressive Volcker-style response will grow.

A rerun of the Volcker shock or something like it is a real possibility, if not a likelihood. Which makes understanding what the first one entailed”

How Did the Fed Not Anticipate the Inflation Surge?

“As the greatest inflation spike of the last 50 years occurs, the utter failure of economists, their models, and many pundits to foresee what was coming is worth highlighting. Of course, the biggest malfunction in the story was that of the Federal Reserve itself, which had a clear mandate to keep prices stable and seems surprised by their lack of stability.

It’s no understatement to say that the Fed failed to properly anticipate the inflation surge. On Feb. 8, 2021, Raphael Bostic, the president of the Atlanta branch of the Fed, said, “I’m really not expecting us to see a spike in inflation that is very robust in the next 12 months or so.” A few days later, Boston Fed President Eric Rosengren echoed this sentiment, noting that he would be “surprised” to see broad-based inflation sustained at a level of two percent before the end of 2022.

As the saying goes, problems often start at the top. When testifying before the House Financial Services Committee in February 2021, Fed Chair Jerome Powell predicted that it might take more than three years to hit the two percent inflation goal.

Around the summer of 2021, inflation became hard to ignore. Yet Fed officials insisted that it wasn’t yet time to roll back their temporary policies because they weren’t responsible for the rise in prices. The main villain was identified as supply-chain restraints. Once resolved, we were told, inflation would prove to be transitory. Testifying in June of last year before a House subcommittee, Powell said:

“If you look…at the categories where these prices are really going up, you’ll see that it tends to be areas that are directly affected by the reopening. That’s something that we’ll go through over a period…then be over. And it should not leave much of a mark on the ongoing inflation process.”

During a speech in Jackson Hole, Wyoming, last August, Powell again echoed this sentiment. He also noted that “longer-term inflation expectations have moved much less than actual inflation or near-term expectations, suggesting that households, businesses, and market participants also believe that current high inflation readings are likely to prove transitory.”

But as Hoover Institution economist John Cochrane has been reminding us all along, long-term inflation expectations are notoriously poor predictors of inflation. Sadly, few listened, and team “transitory” was born.”

Fed’s Powell pumped trillions into the economy. Now, he may be the party killer.

“The Fed has penciled in three rate hikes this year, and the first could come as soon as March.”

“Adam Ozimek, chief economist at freelancing platform Upwork, said the Fed misjudged how large the inflation spike would be, though he still thinks — as the Fed previously argued — that price increases will eventually start to cool on their own. He said the danger instead is that the Fed will overreact to levels of inflation that ultimately prove temporary, hurting the millions who still haven’t returned to the labor force.
“Inflation is by any measure extremely high, yet labor slack remains significant as well and we are far from full employment,” he said. “The policy challenge is far more complicated than in 2018, when Powell faced uncertainty about labor slack but without the added pressure of high inflation.”

Still, others have praised the Fed’s restraint amid the price spikes, keeping rates low and allowing the job market to heal more quickly. They argue that inflation is significantly being fed by supply chain issues that the central bank isn’t equipped to solve.

Former Fed Chair William McChesney Martin once said the central bank’s job was “to take away the punch bowl just as the party gets going.” But Sahm argued that a few rate increases don’t have to ruin anything.

“Things are getting better,” she said. “We need to pour a little less punch in the punch bowl.””

Biden made one of the best decisions of his presidency this week

“Powell’s innovation as Fed chair was to really care much more about employment, relative to inflation, than his recent predecessors had.

In 2019, he began lowering interest rates during an economic expansion, a genuinely unprecedented action that conceded the rate hikes he introduced the previous year were a mistake.

He repeatedly invoked homelessness and high Black unemployment as reasons to keep pushing rates lower, saying the job wasn’t done until it was done for everyone.

In 2020, he issued a new formal framework explicitly pushing the Fed away from its traditional fixation with inflation and toward worrying about employment.

He made these changes in the context of a world where inflation was consistently low and employment and wages were short of where they should’ve been. But in 2020, and especially 2021, the tasks before Powell changed. First he had to prevent a pandemic-driven collapse of the global financial system akin to what occurred in 2008.

Then he was — is — faced with the question of what to do now that inflation is high for the first time in decades. That challenge, and the question of whether Powell can be as effective at controlling inflation as he has been at promoting employment, will frame his next term.”

Is Inflation Back for Good?

“On June 10, the Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) “increased 0.6 percent in May on a seasonally adjusted basis after rising 0.8 percent in April,” bringing the year-over-year price increase on all items to 5.0 percent.

“This was the largest 12-month increase since a 5.4-percent increase for the period ending August 2008,” the BLS noted. And when you take out food and energy, the resulting yearly rise of 3.8 percent was “the largest 12-month increase since the period ending June 1992.””

“Two main schools of thought contend among those who believe that massive sustained price inflation is either inevitable, or already here: Milton Friedman’s monetarism, and the more bubble-focused analysis associated with the Austrian school of economics.

Friedman’s theory, which was widely accepted in the economics and finance professions decades ago but has been waning since asserts that “inflation is always and everywhere a monetary phenomenon.” The correlations were indeed observable in the 1960s and 1970s, but the theoretical prediction of increased money supply leading to economy-wide price inflation has been failing to come true for many years now.

Why might that connection between money supply and price be slipping? Theories include the Federal Reserve paying banks interest to just sit on uncirculating money. Another is that the “velocity” of money—the rate at which one dollar is used to purchase goods and services in a given time period—has fallen by nearly half since the beginning of the century.

But America has seen a lot more money lately, with the overall supply of the M1 monetary measure more than quadrupling in just the past 15 months. We have also in COVID times seen government injections of cash into the hands of business and citizens into the trillions, with the Federal Reserve committed to buying as much government debt as the government wants to feed into its spending machine.”

“Austrians, like monetarists, also see a necessary logical connection between increased money supply and higher prices (adjusted for the amount of goods and services available for the money to buy). But they don’t automatically assume that more money will mechanistically translate into economy wide CPI inflation. Rather, inflation might mostly be expressed in specific sectors, such as stocks, crypto, housing, collectibles, and any other available means to get out of dollars and into something with more perceived promise of holding value.

But those specialized areas where dollars flood into can all too often prove to be bubbles of “malinvestment” which, once popped, can produce economic wreckage and damaging policy reaction, the Austrians warn.”

“Modern Monetary Theory, the hot modern excuse for the government to spend whatever it wants to spend, posits that as long as any resources of labor or capital in the economy are not currently being used productively, then more money in whatever amount presents no inflationary threat. MMTers will tell you that their hypothesis comports to the reality of the past few decades better than the monetarist insistence that more money equals more (inflationary) problems.

So what’s the MMT and/or governing-Democratic explanation for the recent surge in CPI and sectoral inflation? It’s all about unleashed demand as lockdowns fade and bank accounts swell with federal stimulus bucks, with manufacturers temporarily bidding up prices to make sure they are ready for the pent-up, post-COVID buying spree. After the recovery shakes out, the argument goes, prices will stop noticeably rising.”

“The White House Council of Economic Advisers (CEA) argued in April that the CPI spike seems scary only because of the “base effect” of rising from very low inflation in the pandemic-scarred year 2020. Fed Governor Lael Brainard assured us last month that we just need to be “patient through the transitory surge.” (Inflation hawks are quick to retort that this is what the Federal Reserve folk insisted back in the 1970s, before our nation’s last big inflationary spree, when for three years, 1979–81, CPI was rising over 10 percent per year.)

The Fed swears it will start tapering off its seemingly endless run of buying Treasury and mortgage-backed securities if the central bank’s inflation target of 2 percent looks poised to be breached long-term. Temporary surges worry the bankers less.

And even if CPI inflation continues to increase like it has this spring, the central bankers are confident they can rein it back in. As Brainard wrote: “If, in the future, inflation rises immoderately or persistently above target, and there is evidence that longer-term inflation expectations are moving above our longer-run goal, I would not hesitate to act and believe we have the tools to carefully guide inflation down to target.””

How Trump’s team amassed a $1 trillion war chest for Biden to deploy

“The Treasury has a cash pile of well over $1 trillion, which will allow the government to quickly disburse money in line with the sweeping new law, including direct checks to millions of Americans that are expected to start hitting bank accounts in the coming week. That robust rainy-day fund was built last year by then-Treasury Secretary Steven Mnuchin, who preemptively cranked up the pace of government borrowing, unsure of how and when Congress might mandate further relief measures.

So, despite concerns that markets will be flooded with new U.S. government debt to pay for the rescue package, the Treasury Department might not have to change its borrowing plans much at all to fund the legislation signed into law”

““There are enormous implications for everyone else, but the Treasury was out in front of this nine months ago,” said Lou Crandall, chief economist at research firm Wrightson ICAP.
The advance moves by the Trump team are proving to be key to limiting turbulence in government debt markets from such massive spending. Bond yields have already been inching up in recent months due to brighter prospects for the economy”

“The planning by Mnuchin also demonstrates that, even as Republicans now balk at the price tag of Biden’s rescue package, the Trump administration itself was prepared for the possibility that the economy would need another big infusion of cash to fully emerge from the pandemic.”