Eve is here. This post provides a much-needed antidote to falling US inflation, even though the economy (to most people) still looks pretty good. The Fed’s performance could soon be tested by a port strike that is likely to last long enough to cause supply chain pressures and an escalation in conflict in the Middle East that will drive up oil prices.
Written by Thomas Ferguson, Research Director, Institute for New Economic Thinking, Professor Emeritus, University of Massachusetts, Boston. Mr. Servers Strom, Senior Lecturer, Department of Economics, Delft University of Technology. Original publication location: https://www.ineteconomics.org/perspectives/blog/the-fed-and-the-soft-landing-policy-or-luck
The biggest factor explaining the economy’s strength is the continued importance of the wealth effect in sustaining consumption among the wealthy.
End-of-summer festivals have long traditionally been premier events in the world of art and music. Now, courtesy of the Federal Reserve Bank of Kansas City, central bankers are retrofitting it with their own versions of Bayreuth and Salzburg. The conference was held at Jackson Lake Lodge in Grand Teton National Park in Wyoming in late August.
This year’s meeting focused on the effectiveness of monetary policy. The atmosphere was upbeat, in marked contrast to some previous conclaves. Central bankers were seen visibly relieved and celebrating the decline in inflation, which has fallen to less than 3% from a peak of around 10% in early 2022. They were happy to take a few laps of victory, confident that their policy response to soaring inflation was ultimately successful (Powell 2024). Their greatest source of pride appears to be their “credible commitment” to defeating inflation, which, according to official explanations, means central banks will “do whatever it takes” to restore prices. It is said to have sent a decisive signal to markets, companies and workers. Stability.
It was this resolute commitment, they believed, that prevented a 1970s-style wage and price inflation spiral by keeping inflation expectations “fixed,” as central bankers like to say. . As a result, they thought, inflation fell without causing a deep recession, a feat some mainstream economists had predicted.
But how much credit does the Federal Reserve really deserve? Is the impressive macroeconomic turnaround a testament to the Fed’s credibility, determination, and wisdom? Or was it just luck that inflation fell without unemployment rising sharply?
our New INET working paper We analyze the argument that the Federal Reserve is primarily responsible for the decline in U.S. inflation and compare several different quantitative approaches. These indicate that the Fed can plausibly claim between 20 and 40 percent of the decline.
The paper then examines the contention of central bankers and their supporters that the Fed’s firm commitment to maintaining inflation expectations played a key role in this process. The paper shows that this was not the case. The Fed’s own research shows that low-income Americans don’t believe assurances from the Fed or anyone else that inflation is fixed. A recent study by the International Monetary Fund (see Gourinchas 2024) also concludes that expectations are empirically irrelevant in determining the recent rise in inflation and the subsequent fall in inflation.
U.S. inflation actually fell because global supply-side constraints eased and food and energy prices fell over time. A stronger dollar contributed to lower dollar costs of imports and weaker export demand for U.S. products. The Biden administration also released Strategic Petroleum Reserve inventories at critical times and made intermittent efforts to resolve port disruptions.
But a major factor in the decline is the simple fact that American workers have generally been unable to raise their nominal wages in response to rising costs of living. Unlike in the 1970s, when American workers (and unions) were still able to protect real wages from rising inflation, falling real wages absorbed shocks to the price level. We present clear evidence that contradicts the general claims made by, for example, Autor. others. (2023) state that the coronavirus or the emergence of the Biden administration has led to fundamental structural changes in the U.S. labor market that favor the most disadvantaged workers. I wish this was true.
Based on our analysis, it is clear that central bankers are claiming credit for developments that are largely beyond their control. The problem is bigger than just their habitual arrogance. Because Jackson Hole’s self-congratulatory assessment of monetary policy justifies a new round of what John Kenneth Galbraith (1973) called “useful economists” and fundamentally broken macroeconomic models. This is because it supports The “inflation-expectation channel” plays a central role in wage-price dynamics. The celebration also distracts from the Fed’s continued failure to address or even acknowledge the main drivers of inflation, particularly the services sector.
The paper then addresses the obvious question of why soaring interest rates have not so far led to a significant rise in unemployment. We show that Benigno and Eggertson’s recent argument that this can be explained by changes in vacancy rates is contradicted by the evidence. Benigno and Eggertson (and many others) treat recruitment data with complete ignorance. They do not take into account the false positions and the possible surge in cases of coronavirus infections. we think Vacancy data has no value as evidence of the actual state of the labor market.
The biggest factor explaining the economy’s strength is the continued importance of the wealth effect in sustaining consumption among the wealthy. As we have highlighted in several previous papers (Ferguson and Storm 2023, 2024a, 2024b, 2024c), this stems from the Fed’s quantitative easing policy. Absent a sharp decline in wealth, the continued importance of the wealth effect is likely to drive inflation, particularly in the service sector. Therefore, we believe there will be continued shocks from climate change and a multipolar global economy. In the United States, weak regulation in the face of violent plutocracy could also threaten price stability as demand for electricity surges from artificial intelligence and cryptocurrency mining companies.
References
look original post For reference
