America Needs To Rediscover Sacrifice In Inflation Fight

The Fed needs to show some conviction this week.

The June FOMC meeting is an opportunity for policymakers to seize the moment and put meaningful action behind what, let’s face it, are little more than words so far.

May’s CPI report was a disaster. Inflation is broadening out and embedding itself across the economy. It felt like a tipping point. Just an hour and a half after the release of the inflation data, the preliminary read on University of Michigan sentiment for June showed consumers have never felt worse. Inflation is the bane of Americans’ existence, or at least that’s how consumers perceive the situation, which strikes at the heart of the problem. The risk of longer run expectations becoming unanchored is rising.

The figure (below) is cherry-picked from May’s CPI breakdown. I say “cherry-picked” in the interest of being intellectually honest and transparent, but at the same time, I’d emphasize that it’s not cherry-picked if you think common sense counts. The figure shows food, fuel and shelter categories and subcategories. I didn’t employ any kind of scientific or statistical rigor in choosing which categories to present. Some of the items shown are subcategories of other items, for example. But I’m not sure statistical rigor is particularly relevant at this juncture. What matters for everyday people and, in turn, for their price expectations, is how quickly prices are rising for the things they need and the things they’re likely to buy on a regular basis.

The “L” in the figure stands for “Largest.” So, “L-Feb. 1987” is “largest since February 1987,” for example. “L-EVER” is “largest ever.” If you doubt the utility of employing an unscientific approach to data analysis when families are struggling with double-digit price increases for food, shelter and energy, I’d implore you to consult Jerome Powell, who last month emphasized the primacy of common sense over rigor. “Now is not a time for tremendously nuanced readings of inflation,” he said, on May 17. The figure (above) is an effort to honor that exhortation.

The problem, of course, is that rate hikes won’t unblock Ukraine’s ports. Policy hawks can’t conjure chickens. Balance sheet runoff won’t bring forth more fuel or cooking oil. Tighter policy can help ameliorate the rise in property prices, but the die is cast on the home front. Rising house prices work their way through to shelter inflation on a lag. Bleeding the real estate market now may help later, but driving up mortgage rates and letting mortgage backed securities roll off the balance sheet can’t rewrite the history of the pandemic real estate boom. The value of real estate in America rose by one trillion or more for six consecutive quarters through the end of March. That’s now showing up in the inflation numbers and it’s also hurting consumer sentiment.

So why bother? What’s the use of draconian rate hikes from the Fed if rising prices for the things that matter to families are primarily the result of a series of exogenous shocks?

Well, because the Fed keeps telling the public that inflation is their purview, and the White House, determined to deflect blame for surging prices ahead of the midterms, is keen to drive home the message. Two weeks ago, Joe Biden hosted Powell for a partially-televised Oval Office meeting, and on Friday, following May’s inflation report, Brian Deese deflected again, employing the same strategy as Biden — namely, citing the administration’s “respect” for Fed independence. “What the [inflation] numbers underscore is what the president has been saying and what we are focused on — which is fighting inflation has got to be our top economic priority,” Deese told Bloomberg. “The Fed has the tools that it needs, and we are giving them the space that [they] need to operate.”

But they don’t. The Fed doesn’t have “the tools that it needs.” On March 31, Zoltan Pozsar quipped that “you can print money, but not oil to heat or wheat to eat.” So, you can’t quantitative ease (used here as a verb) commodities. But you can’t quantitative tighten them either. Central banks can’t print corn, but they also can’t rate-hike milk.

With apologies to the Milton Friedman disciples, the idea that inflation is “always and everywhere a monetary phenomenon” works as an axiom only in an absurd theoretical vacuum and, somewhat ironically, only under some semblance of normal economic conditions. If the quantity of money increases dramatically and the supply of critical commodities shrinks simultaneously due to a series of epochal exogenous shocks, blaming “too much money” instead of not enough food and fuel is to be deliberately obtuse — to subjugate reality to theory. In a nuclear or climatic apocalypse, food and fuel would become so scarce that the vast majority of people wouldn’t be able to source any at all. Inflation would be infinity, but it surely wouldn’t be a “monetary phenomenon.”

Fortunately, we’re not there yet, where “there” means the post-apocalyptic monochrome from Cormac McCarthy’s The Road, or the sun-baked, leather-clad free-for-all from Mad Max. All the food isn’t gone, and although you wouldn’t know it, there’s actually no real “shortage” of fossil fuels, per se. Currently, “too much money” is indeed “chasing” scarce stuff, and there’s room to force some of that demand into hibernation. That’s where the Fed (and, I’d suggest, the White House) needs to be honest with Americans who, in turn, need to be honest with themselves.

As bleak as this most assuredly is, the Fed needs to crimp demand for inelastic goods and services. That’s not what Deese or Biden means when they say the Fed has the tools it needs, but in reality, that’s the only thing such statements can mean if they’re supposed to be true.

The Fed needs to tell the public that it intends to hike rates such that jobs are lost and such that the accompanying economic pain materially reduces demand for necessities. After all, the rise in inflation is in no small part a function of rising prices for those necessities, and if the Fed can’t conjure fuel, food and houses, then how else can they address the problem?

They could start with a 100bps rate hike this week and a deliberately terse policy statement. They might also consider suspending the SEP and the dots. Powell should hold one more press conference and then suspend them until further notice. In that final press conference, he should be as forthcoming and unequivocal as possible: The Fed will hike rates into restrictive territory by summer’s end, and not necessarily at scheduled meetings. The pace of balance sheet runoff is subject to change, and outright sales of mortgage backed securities are a near-term likelihood. The Fed will make one concession: Runoff of Treasury holdings will always be calibrated to ensure smooth functioning of the Treasury market, and, relatedly, at no point will the Fed countenance a repeat of the September 2019 funding market squeeze. (The existence of the standing repo facility would make that latter pledge superfluous, but they could make it anyway.)

Plainly, the Fed won’t go that route. They’ll persist in half-measures (figuratively and literally in the sense that 50bps is a half percentage point) and Powell will continue to insist he has the tools he needs to combat inflation without specifying how, exactly, his tools work, if not by destroying demand.

Nobody should delude themselves. This is a charade. How many CPI reports is enough? How long are we going to pretend that “tools” means anything other than the capacity to engineer a recession? What can the Fed possibly do to bring down the price of wheat if not force families to eat less? How can the Fed possibly bring down gas prices without forcing families to cancel vacations? They can’t. Powell, Biden and economists can talk around that reality all day, but it won’t change the facts. And every, single month those facts will show up in CPI and PCE prices. And every, single month we’ll obfuscate to avoid accepting reality.

If America had an adequate social safety net that protected the most vulnerable from abject poverty, this would be a much simpler calculus. That is: If we were sure that no one would literally starve or go without shelter, the Fed and the White House could make a few simple suggestions. Spendthrifts need to stop spending. Clark Griswold needs to cancel this summer’s Walley World fun quest. And tens of millions of obese Americans might take the opportunity to go on a diet.

Of course, America doesn’t have an adequate social safety net. And whose fault is that? This was a (nominal) democracy until six years ago. The government you elect is the government you deserve. Shout about special interests and government capture all you like, but the system didn’t build itself. We constructed it over 200 years, many of us willingly acquiescing to objectively perilous policies over and over again in the name of expediency or some other excuse.

Bringing down inflation is going to require sacrifice. It’s doubtful that the American people are capable of sacrifice at scale anymore. Both monetary and fiscal policy reflect those doubts.

Invariably, some readers won’t be enamored with all of the above. If that’s you, don’t fret. I penned a “regular” FOMC preview too: “Volcker Or Bust. What To Expect From June’s Fed Meeting”