In March, the Federal Reserve will likely start raising interest rates – maybe three or four quarter points over nine months. This is barely enough to bring inflation down to 2%.
Heartbreaking at 7%, demand for goods and services will continue to outstrip supply.
Omicron cemented hybrid work – adding to housing inflation in suburbs and more remote communities beyond commuting distance to major employment centers. Raising mortgage rates by less than one percentage point will do little to reduce housing costs.
Household and business balance sheets are teeming with enough unspent stimulus money that the continued shift to goods from services like lunches at big-city restaurants is hardening into permanent patterns. Even with slightly higher financing rates, automakers and remote work equipment makers will have leeway to raise prices.
Supply chains remain fragile – as evidenced by grocery store shortages – and will slowly improve. Chip shortages will limit the supply of cars and electronic gadgets until 2023.
Restaurants and retailers must pass on higher costs for food, labor and periodic closures for the traffic slowdown imposed by new strains of COVID. Otherwise, they bend.
Better remote collaboration software is coming. Real eye contact and a real sense of presence from innovations like Google’s Starline will prove the harbingers of a metaverse that’s more of a workplace than a destination for games and gigs. The benefits will be significant and technology companies do not need to borrow to invest.
When Paul Volcker became Fed Chairman, inflation was nearly 12%.
I spoke with him at the time and was impressed with his understanding of the distortions in inflationary expectations imposed on asset purchases – in particular, housing which was then also going through shortages of building land.
A more powerful figure than his predecessor, William Miller, and less political and easy-going than President Jerome Powell or European Central Bank President Christine Legarde, he pushed the federal funds rate up nearly seven percentage points in eight month. The economy slipped into recession, it calmed down, then hit the metal by raising the key rate to 19%.
These days, such drastic action probably isn’t necessary, but monthly one-percentage-point increases until inflation hits 2% again would do the trick.
It is difficult to say that the labor market is not at full employment with an unemployment rate of 3.9% and more than 10 million unfilled jobs. It is equally difficult to say that we are at full employment with so many people laid off from old service jobs still sitting on the sidelines. Interest rates should be pushed high enough to cause additional unemployment, otherwise inflation will continue to outpace wages, exacerbate inequality for many years to come, and tax the elderly who are disproportionately dependent on various forms of income. fixed income investments.
We don’t need another handout of extra unemployment benefits that exceed lost wages. Instead, relocation and retraining incentives and subsidies to enroll in Ministry of Labor apprenticeship programs. State unemployment benefits should be portable for those who move abroad for training.
Volcker-style increases in the fed funds rate would flatten or invert the yield curve — that is, when short rates rise more than long rates — and further shore up the banking sector.
Simply, banks rely on the spread between long rates on mortgages and the like and short rates for what they pay for deposits and other loanable funds. Smaller banks are more dependent on lending income and larger banks more on trading fees, electronic payments, etc.
The last thing America needs – other than another COVID shutdown – is to rush more bank consolidation that reduces competition and increases big bank bonuses.
Since 2008, the Fed has been paying commercial banks interest on the reserves they keep at the central bank. Tilting the yield curve could make the interest the Fed pays banks higher than what it collects on bonds and push them into a deficit.
Since the Fed can print money for whatever madness it chooses – the pandemic has proven this – it can photocopy its way out of this corner. But what an embarrassment!
The Fed is expected to complement larger rate hikes in the fed funds rate by selling some of its long-term Treasuries and mortgage-backed securities to raise long rates.
It would steepen the yield curve to avoid central bank losses and suck liquidity out of the system where it hurts the most – too much demand for big-ticket items like cars and houses.
The whole issue of balance sheet reduction has baffled Fed policymakers. However, as the chronic bad calls for inflation at both the Fed and the ECB have established, the kind of foresight and clarity of thought Mr. Volcker brought to the Fed is not a hallmark salient feature of central banks run by politically motivated lawyers.
• Peter Morici is an economist and professor of business emeritus at the University of Maryland, and a national columnist.