Analysis: The Fed’s Finding More Excuses & Ways to Undermine the Economy

By at 2 February, 2023, 11:54 am

by Raymond J. Keating –

The Federal Open Market Committee (FOMC) announced on February 1 that it was raising the federal funds rate by a quarter point to a range of 4.5 percent to 4.75 percent. And more rate hikes were promised.

It also was noted in the FOMC statement that “Inflation has eased somewhat but remains elevated.”

In fact, both the Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) Index show that inflation has come down notably. Over the past six months, based on these measures, the annualized inflation rate has been running between 1.5 percent and 2.1 percent. That’s been welcome news.

More Troubling Fed Action

But the Fed’s insistence that its effort to undermine economic growth has been the cause of this calming of inflation, and that this effort must continue, is wrongheaded and not welcome.

The Fed is now drilling down to changes in prices within various industries and sectors to justify its ongoing rate hikes. That’s troubling because at any moment in time, the prices of various goods and services rise – some at more rapid rates than others – while prices of other products fall. Inflation is an ongoing rise in the general price level. It’s not about rising prices in one sector or even a certain group of industries.

So, while core inflation – that is, the change in prices less changes in food and energy prices – isn’t inflation at all, even less relevant from an inflation measuring and fighting perspective is what’s become known as supercore inflation. The Wall Street Journal has noted: “The name is a nod to the Fed’s focus on a slimmer set of prices that remain stubbornly high. Supercore inflation comprises the price of services — things such as barbers, lawyers or plumbers — excluding energy and housing. It’s the Fed’s new favorite inflation gauge as it tries to diagnose the pace of inflation and the current and future health of the U.S. economy. Fed Chair Jerome Powell has said that it ‘may be the most important category for understanding the future evolution of core inflation.’”

The dangers, and absurdity, of having the Fed focus on price changes in particular sectors of the economy should be obvious. It’s bad enough that the Fed fantasizes that it can use interest rates to manipulate the economy in order to get the level of economic and/or employment growth, and therefore inflation, it wants is bad enough, but now the Fed is trying to achieve price changes, for example, in certain service sectors. That only points to more economic troubles resulting from policy missteps.

Let’s be clear. The Fed is absolutely right to focus on inflation running at a stable, roughly 2 percent rate. It’s also wise that the Fed is trying to rein in the unprecedented and irresponsible levels in the monetary base (i.e., currency in circulation plus bank reserves) that the Fed itself created from 2008 to late 2021, as that breathtakingly loose money has contributed to some degree to the recent run of high inflation.

But the Fed’s focus on trying to tune the economy by manipulating interest rates is wrongheaded, and is undermining economic growth. For good measure, a Fed focused on prices in certain sectors, rather than on actual inflation, amounts to even more uncertainty regarding policy and potential negative consequences for the economy.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest book is The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist.


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