Fed Policy in a Nutshell: Live in Hope; Die in Despair

During his post- FOMC meeting press conference, Federal Reserve Chairman Jerome Powell said, “Hope for the best; plan for the worst.”

I think he meant, “Live in hope; die in despair.”

The Federal Reserve raised interest rates another 75 basis points to 3.25% in another attempt to cool “transitory” inflation. The move was widely anticipated after the Consumer Price Index (CPI) came in hotter than expected in August.

The last time interest rates were this high was January 2008.

You remember what happened in 2008, right?

In its official statement, the FOMC said the central bank is “strongly committed” to bringing inflation back to the mythical 2% target, and that it “anticipates that ongoing increases in the target range will be appropriate.”

Unfortunately, by the Fed’s own admission, that’s going to take a while. Meanwhile, get ready to feel some pain.

“I wish there were a painless way” to get inflation down, Powell said during his post-meeting press conference, “but there isn’t.”

The central bank now projects its favorite inflation measure (core personal consumption expenditure index) to hit 2.3% in 2024 and 2.1% in 2025. CPI won’t likely fall to the 2% range until 2025. Powell specifically talked about rising prices for shelter, saying, “We’re looking for it to come down, but it’s not exactly clear when that will happen. It may take some time. Hope for the best, plan for the worst.”

And in fact, projecting inflation to fall to 2% in the next couple of years seems like a plot from a fantasy novel. As aggressive as the Fed moves may seem, they remain totally inadequate to rein in inflation galloping along at an 8.3% clip.

Officials now project interest rates will hit 4.4% by the end of the year and top out at 4.6% in 2023. That’s up from a projected 3.8% peak at the last FOMC meeting. But in order to tackle inflation, the Fed needs to push rates above the CPI. I don’t need tell you that 4.6 is below 8.3. That’s why Peter Schiff insists the Fed won’t bend this inflation curve.

As long as we have interest rates below the inflation rate, even if they’re higher, they’re still negative, and negative interest rates put upward pressure on inflation. You can’t fight inflation with negative interest rates. It’s like saying, ‘I’m going to fight this fire by pouring gasoline on it. It’s just that I’m only going to pour a little bit of gasoline, not as much gasoline as I was pouring on before.’”

On top of that, Fed rate hikes alone won’t tame inflation.

A paper published by the Kansas City Federal Reserve Bank even conceded this point, arguing that the central bank can’t slay inflation unless the US government gets its spending under control. In a nutshell, the authors argue that the Fed can’t control inflation alone. US government fiscal policy contributes to inflationary pressure and makes it impossible for the Fed to do its job.

Trend inflation is fully controlled by the monetary authority only when public debt can be successfully stabilized by credible future fiscal plans. When the fiscal authority is not perceived as fully responsible for covering the existing fiscal imbalances, the private sector expects that inflation will rise to ensure sustainability of national debt. As a result, a large fiscal imbalance combined with a weakening fiscal credibility may lead trend inflation to drift away from the long-run target chosen by the monetary authority.”

That seems unlikely.

But while the Fed’s tight monetary policy is unlikely to end inflation, it will continue to drive the economy into the ground. As Skanda Amarnath, executive director at Employ America told Reuters, “Everyone should assume the Fed is committed to engineering a recession.”

The Fed even concedes this fact – thus Powell’s warning about pain. But don’t worry. The Fed chair said once the central bank gets inflation under control, “things will start to feel better for people.”

So, look forward to brighter days — in 2025.

Maybe.

In fact, the central bank seems to be wildly underestimating the pain in store for the economy.

The Fed projects GDP year-end growth will come in at 0.2% and then rise to 1.2% in 2023. But we’ve already had back-to-back quarters of negative GDP growth. That used to be the definition of a recession until the spinmeisters at the White House updated the definition. And things aren’t looking much better for Q3. The Atlanta Fed recently downgraded its third-quarter growth projection to 0.3%.

Most people seem resigned to the fact that a recession is in the cards. But they insist it will be short and shallow. This is almost certainly more wishful thinking. Why should anybody believe it will be short and shallow?

As Schiff pointed out, the bust needs to be proportional to the boom.

We’ve never had a boom this big. We’ve never had interest rates this low for this long. We’ve never had an economy more screwed up than the one we have right now. We’ve never had bigger asset bubbles, bigger debt bubbles, more misallocations of capital and resources. So, we have more mistakes that we need to fix now than ever before. So, how are we going to do that with a short shallow recession? We’re not. It’s going to be a massive recession.”

The question is how long will the Fed keep making a show of fighting inflation? At what point will the central bank pivot back to blowing air into the bubble economy? Schiff said the Fed has “no stomach” for the kind of economic chaos coming down the pike. “And that’s why the Fed is going to pivot.”

That leads to other questions. Will the Fed pivot as soon as it can no longer plausibly deny the imploding economy? Or will it keep pushing the envelope until it rips and then pivot? Schiff said, either way, the end result is the same.

As long as it pivots at all, that means inflation is going to run out of control.”