Sometimes it’s hard to know who’s serious and who’s just after some press these days.
“I see interest rates in the US going to 9%,” Mark Mobius told Bloomberg. “Sorry. How much?” the anchor interjected. “9. Simply because if inflation is 8%, the playbook says you’ve got to raise rates higher than inflation, which means 9%.”
With apologies to Mobius, there’s nothing “simple” about that. Notwithstanding the Fed’s unfortunate penchant for fighting the last war and perpetually skating behind (as opposed to ahead) of the proverbial puck, you have to think about the policy rate in terms of where inflation will be, not where it was according to last month’s CPI print, which is itself backward looking in many ways. If you don’t, you risk running a laughably draconian regime wherein on-the-ground inflation (i.e., what won’t show up in the official data for months) falls, while you ratchet up rates, resulting in wholly oppressive policy settings conducive to something worse than a recession.
Mobius acknowledged that. “Of course that theory will go out the window if CPI goes down but I don’t see that happening anytime soon.”
I’d agree that CPI probably isn’t going to fall sustainably or uniformly soon (I don’t know about “anytime soon”) but nevertheless, the prospect of a 9% policy rate in the US is farcical. Admittedly, I thought 5% was farcical, and just last week terminal rate pricing nearly reached 5%. But if Mobius really thinks the Fed is going to hike to 9%, then he (better than anyone) should know that emerging markets are likely to implode.
Meanwhile (and relatedly) Larry Summers is irritated with Paul Krugman, who made the “mistake” of suggesting that real time indicators of inflation point to slower price growth. Summers, still high on his own forecasting success, mercilessly attacked Paul for a New York Times Op-Ed, in which he (Krugman) said that although he’s “reasonably sure that the economy is indeed running too hot, so the Fed was right to raise rates,” what’s less clear is “whether the Fed needs to keep raising rates, given that much of the effect of past rate hikes has yet to be felt.” He focused specifically on housing, but the gist of his argument is captured in the following short excerpts:
[O]ur traditional inflation measures — core inflation, median inflation and so on — are likely to continue rising rapidly for a while as they catch up. From the point of view of consumers, this will represent a real increase in the cost of living. But if you’re trying to assess economic overheating, standard measures will be telling you about the state of the economy a year ago — not the state of the economy today.
So what’s the moral of the story? Basically, simple rules for assessing where inflation is right now are broken. We’re in judgment territory — and that leaves lots of room for argument.
If it was an “argument” Paul was after, he got it.
“Krugman now focuses on housing and the well-known point that government indices lag private sector indices of newly leased residences,” Summers began, before simply destroying Krugman’s well-meaning missive for the shoddy piece of work that it most assuredly was, even as I generally agree with the overarching premise. Summers wrote that,
Krugman would be more convincing if he had focused on the housing distortion when it was holding overall inflation down in 2021. He would be more credible if he acknowledged that new rental price inflation of his cited measure (Zillow) is still running at 6%. He would also be more credible if he pointed out that lags [aside] there was a large gap between the level of residential prices measured by the private sector and government. These have historically moved together, and I’d guess the official indices will catch up. Krugman would also be more convincing if he acknowledged that dropping out the median observation in a group of observations does not change its median. In the Op-Ed, Paul then shifts his attention to the labor market as a guide to underlying inflation. I agree that wages are a kind of super core measure of inflation. Paul focuses on average hourly earnings in the employment survey. He neglects to point out that it is badly flawed by composition effects. Nor does he observe that better indices like the Wage Growth Tracker and the ECI suggest a much less benign picture of wage inflation. Having stressed the distinction between new and continuing prices in the context of housing where it works to allay inflation concerns, Paul neglects it in the context of wage inflation. The gap between wage gains for those changing jobs and those staying in jobs is at record levels. This suggests accelerating wage inflation. Given dismal productivity growth, likely caused by quiet quitting, wage inflation will have to come down significantly if sustained months near 2% inflation is to be attained. I do not understand the basis for believing this is likely without a meaningful recession.
It doesn’t say much for Krugman (or The New York Times, for that matter), when Summers’s Twitter critique was infinitely more trenchant than an actual Op-Ed published by America’s “paper of record.”
Krugman tried to respond (on Twitter) but it was too late. “I’ve been clear about getting it wrong last year. But we need more than gotchas — you didn’t talk about rent lags then, but you’re talking about them now,” he told Larry. “Don’t many indicators suggest that underlying inflation is better than the standard numbers say?”
I actually don’t know the answer to that latter question. And it doesn’t sound like Krugman does either. In fact, the whole point of the Op-Ed was to say that, as he put it, “simple rules for assessing where inflation is right now are broken.” Given that, the guy who got it right (Larry) has a better claim on authority than the guy who got it wrong (Paul).
Krugman also said he “doubt[s] that any observer of real estate believes that rents are still rising at a 6% rate.” I don’t know about any “observers” and I certainly wouldn’t flatter myself as an “observer” extraordinaire, or at least not when it comes to the rental market in America. But I’d venture that if you talked to a bunch of renters who’ve recently renewed leases, a lot of them would say they’re paying up, not down.
Finally, Mohamed El-Erian suggested the Fed’s failures during the pandemic inflation are an argument for stripping the central bank of its independence. “An independent Federal Reserve is critical to the well-being of the US economy,” he wrote. “Having said that, it is getting harder to justify such independence when four big operational errors (of analysis, forecasts, actions and communication) are accompanied by a lack of accountability.”
Of course, if you strip the Fed of its independence in the name of making it accountable (not necessarily a terrible idea), you have to say who it is the Fed will be accountable to. If El-Erian’s answer is that US lawmakers should have a larger say in setting monetary policy, I’d ask him (and maybe I really will ask him) if he’s apprised of the extent to which Congress is increasingly composed of lawmakers for whom facts are totally malleable. In a country experiencing an across-the-board institutional credibility crisis, Congress stands out as being the least credible of all.
Central bank independence is a relatively new idea, coming into its own only in the past 40 or so years. Over that time frame, though, America’s politics have become increasingly fractious, the electorate increasingly disaffected and the environment increasingly polarized, to the point that some members of Congress avowedly and proudly supported a riot at the Capitol aimed at overturning an election. I’m sorry, but handing monetary policy to US lawmakers is among the worst ideas I’ve heard over the past two years, a stretch defined by bad ideas.
Summers may win the micro argument, but bigger picture is that krugman is probably correct there. To krugman’s credit he admits his mistakes publicly and loudly. El erian sounds like he is angry he did not get appointed to a high fed position, at least if you listen to his statements. What these critics cannot answer is the following. Granted the Fed was late to tighten. But how about the central banks that went earlier? Not much difference is the answer. Look at Canada and new Zealand for instance. That’s because much of the problem is supply side shocks. The central banks monetary policy in the short and medium term is ineffective on this problem absent causing depression. Summers for one says the Fed needs to go a lot higher, and in the same breath says it will cause a financial crisis. Brilliant! (Note the sarcasm). Gee can I teach at Harvard or Cambridge with such genius?
@RIA – interesting point on the “success” of the early movers.
El-Erian – our Dear Leader rightfully points out El-Erian’s constant criticism of the Fed not following his advice early enough. Perhaps he is correct, but YOU HAVE TO PLAY THE CARDS YOU HAVE BEEN DEALT, NOT THE HAND YOU WISHED YOU HAD BEEN GIVEN.
Whining and screaming about what the Fed “should” have done is pretty irrelevant to what investors should be doing now.
RIA, I cannot speak about the Kiwis, but here in Canada in February there was quite a bit of questioning why the BoC didn’t start hiking even sooner, despite indicating that they were ready to do so imminently. They probably felt that they really couldn’t when the Fed still seemed to be inexplicably doing nothing. You can’t just ignore the Alpha gorilla in the room, especially when our economy is tied very closely to the US. The BoC led the Fed really by only a month or so, but the BoC willingness to do large hikes is where it actually showed leadership. But the start of rate hikes had an immediate effect on our housing market, which peaked in February and has been falling in price ever since. So I would argue that there was a difference to inflation in hiking earlier.
Of course, our housing market was more inflated and we don’t have odd measuring tools like OER here, so the slow weakening of our inflation rate is now evident. This despite almost a 10% drop in the loonie, which is quite inflationary seeing as we import so much from the US.
In the anecdotal observation category, a buddy who sells and installs swimming pools tells me his pre-sales are down 80% compared to last fall. It is one of those luxury items that can easily be delayed or cut when your sense of what you can afford changes. But someone else who sells security software to corporations says suddenly no one is meeting their monthly numbers, despite that being a somewhat non-discretionary item.
Finally, I don’t find it shocking to contemplate 9% on the Fed rate; it could happen unless we all join prospective pool owners in cooling our jets until the constraints in the economy are resolved.
An anecdotal observation from Manhattan — admittedly sui generis when it comes to real estate. Corcoran just put out a mailer letting my wife and our neighbors know that a two-bedroom unit with a bit of outdoor space down the block had sold for $1.4m, $140k above the asking price, with the winning bid one of seven above the ask. My lens is narrow, but it hardly seems as if real estate has come off the boil.
I live in a KC suburb and just got our HOA monthly organ. In it was an ad for a RE broker showing prices paid for about 40 local properties. Only five sold below the asking price. One was listed at $1.2 mil and sold for $1.75 mil. I guess the prices, here at least, are not crashing yet. Average time on the market is increasing but prices still seem to be firm.
In the Pacific Northwest we are seeing actual for sale signs posted at houses for sale as well as an occasional “price reduced” sign. That was not the case recently
I like the idea of Fed accountability a lot, but H explains the problem with it, essentially making accountability not an option, at this point I would rather no Fed instead of a Fed of Congress’ choosing. It would help if the Swedish refrain from handling Nobel prizes to former Fed members, no accountability, no real stake in outcome (no Fed member will go poor) plus positive reinforcement does not provide the best incentive to be careful.
Great article! This commentary on commentaries is why I subscribe. I am not a trained economist, but the current bout of global inflation is not limited to the US and it seems inappropriate to lay the fault with the Fed. Inflation has spiked in the West. How much aid has gone to Ukraine? How much inflationary pressure does this “stimulus” (at least stimulus of the military-industrial complex) produce? Could this stimulus be frustrating the effects of central banks hiking rates? The other concern I have is worker productivity. It seems to be taking quite a bit to “woo” workers back to the job after the covid lockdowns invited them to stay at home. Eventually going to work and showing some hustle on the job will become business as usual, but we are not there yet. I don’t see what the fed can do about that.