• The Federal Reserve had driven monetary policy to historic heights of accommodation: a 9 trillion dollar balance sheet combined with a return to zero interest rates: an easy money paradigm that itself needed to be transitory.
• The Federal Reserve instituted a risk management framework that targeted tail risks instead of an “expected” path of inflation and its resulting impact on the economy.

Moreover, Stiglitz offered two examples from the economy, autos and shelter, that do not conclusively demonstrate the Fed had no impact on inflation. Even Stiglitz’s discourse on inflation expectations is open to varying interpretations. I will tackle each of these issues one-by-one starting with auto inflation.

Auto Inflation: A Counterfactual

Stiglitz makes a big deal out of the obvious fact that the Fed could not solve chip supply problems in the auto industry by hiking interest rates. While the Fed never staked a claim to such powers, and even acknowledge its lack of such powers, this complaint is common among Fed critics who apparently wanted the Fed to leave monetary policy accommodative and lower for longer. Stiglitz pulls the rug from under the Fed by insisting “Given that its interest-rate hikes did not help resolve the chip shortages, it cannot take any credit for the disinflation in car prices.”

So now with auto prices inevitably lower, critics like Stiglitz are declaring victory on the prediction that car prices would eventually come down. Fine. How about a counterfactual? If the Fed had left rates lower for longer is it credible to believe that the path for prices would have stayed exactly the same (or improve)? I claim the answer is no. Assuming lower loan rates encourage and incentivize more borrowing (indeed this is a fundamental premise for accommodative monetary policy), then rock bottom rates would have fueled on-going and even increasing demand for cars and deepened pressures against short supply. In other words, I am claiming auto inflation would have been even worse and could have caused other cascading problems in the economy.

Even throwing away abstract counterfactual arguments, the actual data is not conclusive enough to suggest the Fed had zero (or even little) impact. The chart below juxtaposes new and used car prices with the auto inventory/sales ratio (cars and light trucks). This ratio puts demand and supply into context. While the the ratio bottomed out in late 2021, it is still nowhere close to pre-pandemic levels. Deflation/disinflation should not be this dramatic with the inventory/sales ratio still at historically low levels. I would have expected a price plunge to accompany a much faster recovery in the inventory/sales ratio. In fact, I would have expected the pendulum to at least swing above 1 again.

Sources: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Used Cars and Trucks in U.S. City Average [CUSR0000SETA02], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023. U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: New Vehicles in U.S. City Average [CUUR0000SETA01], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023. U.S. Bureau of Economic Analysis, Auto Inventory/Sales Ratio [AISRSA], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.

In other words, while supply has been slowly normalizing, demand still outstrips supply. This is a condition for higher prices. Yet, resurgent inflation in autos is not likely specifically because high interest rates are constraining and reducing the ability and willingness to pay higher and higher prices. The rate on the 48-month auto loan was last this high in 2002.

Source: Board of Governors of the Federal Reserve System (US), Finance Rate on Consumer Installment Loans at Commercial Banks, New Autos 48 Month Loan [TERMCBAUTO48NS], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.

Finally, domestic banks have also tightened lending standards, likely further constraining the ability to pay higher prices. Lending standards tighten with tighter monetary policy as banks become more risk averse and have a higher cost of funds. This is a Fed effect. From the October, 2023 “Senior Loan Officer Opinion Survey on Bank Lending Practices“:

“In a set of special questions, banks were asked to assess the likelihood of approving credit card and auto loan applications by borrower FICO score (or equivalent) in comparison with the beginning of the year. Significant net shares of banks reported that they were less likely to approve both credit card and auto loan applications from borrowers with FICO scores of 620. Moderate and significant net shares of banks reported that they were less likely to approve credit card loan applications and auto loan applications, respectively, from borrowers with FICO scores of 680. In contrast, a modest net share of banks reported being more likely to approve credit card applications from borrowers with FICO scores of 720, while the likelihood of approving auto loan applications to borrowers with FICO scores of 720 was basically unchanged in comparison with the beginning of the year.”

Thus, I claim the Fed deserves at least partial credit for helping to tap the brakes on demand, in the form of ability to pay, in the face of relatively tight inventories. In other words, I find it compelling to create a narrative around a Fed impact that is at least as plausible as the narrative that completely discredits the Fed.

Shelter Inflation

The dynamics of shelter inflation are complex. I grant Stiglitz the point that higher interest rates can exacerbate inflationary pressures by reducing the availability of construction loans needed to increase supply. Interestingly, Stiglitz does not reference the complementary constrain t on supply from existing home owners who refuse to move and incur the cost of mortgages more expensive than their current ones.

Anyway, I will still point out that it was soaring shelter inflation that provided the signal to the Fed that rates were overly accommodative; the episode was a rare moment in Fed history where it acknowledge an inflationary problem from shelter costs. Historically low mortgage rates stoked demand and led to a mini-mania in the housing market. Prices soared practically uncontrollably for homes. Rent soared alongside home prices. I discussed the “housing trigger” for the Fed in “The Federal Reserve Fears On-Going Inflationary Pressures from Rents” and provided more detail in “Inflationary or A Bubble – Housing Prices Help Push A Fed Driving Recession-Pricing for Home Builders.”

I also provided evidence from a home builder about the impact of the Fed on cooling housing prices in “Lennar Corporation: How the Fed Is Cooling Inflation In the Housing Market.”

In other words, the mere fact that one-year leases on rents cause a lag in disinflation is insufficient to dismiss the various ways in which rent inflation forced the Fed to hike and to maintain its hiking campaign. A counterfactual on post-pandemic housing demand and prices in the face of prolonged accommodative policy should not be controversial: we have lived it three times in the span of just one generation.

Core Inflation

Stiglitz noted the following about headline inflation:

“The pandemic-induced inflation was exacerbated further by Russia’s invasion of Ukraine, which caused a spike in energy and food prices. But, again, it was clear that prices could not continue to rise at such a rate, and many of us predicted that there would be disinflation — or even deflation (a decline in prices) in the case of oil. We were right. Inflation has indeed fallen dramatically in the United States and Europe.”

This was a surprising sidebar when the Fed does not set monetary policy by what happens to food and energy. Adding to the distraction, Stiglitz does not label the inflation numbers her uses to compare to the Fed’s target. For the purposes of this discussion I will assume he is referring to core PCE (personal consumption expenditure, excluding food and energy) since it matches the number he uses for September. Yet, I cannot be 100% sure since the 3.7% change in the PCE in September matches the 3.7% headline change in the CPI (consumer price index) for September. This confusion is technically important because the median PCE sits at 4.4%. Core CPI was 4.1% in September, and the October report delivered the tiniest of cooling at 4.0%.

No matter the lens, these levels and incremental declines are hardly an occasion for final victory. While the Fed has every reason to stop hiking rates and watch what happens from here, these numbers do not tell me the Fed can pack up its toys and go home. Stiglitz takes care of that concern by calling the 2% inflation target arbitrary: “There is no evidence that countries with 2% inflation do better than those with 3% inflation; what matters is that inflation is under control. That is clearly the case today.” On the surface, the logic makes sense except that the period of “Great Moderation”, where deflation was the Fed’s biggest concern, was a period where PCE stayed below 2%. We do not have experience in THIS economy with a Fed that overtly allows inflation to stay well above 3%…and the Fed is clearly in no mood to push its luck.

Source: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.

Inflation Expectations

Stiglitz claims that the Fed also had nothing to do with controlling inflation expectations. Unlike the Fed, markets knew that inflation would naturally correct itself. Stiglitz even challenges the protest that inflation expectations remained calm specifically because of trust in the Fed: “…inflationary expectations remained tame. While some central-bank economists claim that this was due to their own forceful response, the data tell a different story. Inflation expectations were muted from early on, because markets understood that the supply-side disruptions were temporary.” Stiglitz took a debatable point and breathed unfounded certainty into it. Stiglitz focuses on the 5-year forward inflation expectation rate:

“Only after central bankers repeated over and over their fears that inflation and inflationary expectations were setting in, and that this would necessitate a long slog entailing high interest rates and unemployment, did inflationary expectations rise. (But, even then, they barely budged, reaching 2.67% for the average of the next five years in April 2021, before falling back to 2.3% a year later.)”

Yet, a different interpretation is plausible and valid regarding the stability in the 5-year forward expectation. It appears the market has a bias to expect disinflation (especially in response to shocks). Starting between 2015 and 2017, the market finally believed the Fed could hold inflation closer to 2.0%. This milestone came after persistent messaging, in different forms, from the Fed on the 2% target. It seems odd to blame the Fed for a brief spike in inflation expectations at the time the Fed started hiking rates. I find it more plausible to interpret the rapid return to previous levels as evidence the market was once again mollified over long-term prospects with a Fed clearly serious about constraining inflationary pressures.

Source: Federal Reserve Bank of St. Louis, 5-Year, 5-Year Forward Inflation Expectation Rate [T5YIFR], retrieved from FRED, Federal Reserve Bank of St. Louis, November 14, 2023.

Given it appears to take a lot to convince markets the Fed cannot control inflation over the “long-term”, I turned to shorter-term expectations as a more responsive indicator. It turns out that the 3-year consumer expectations peaked right as the Fed finally dropped the notion of transitory inflation in November, 2021. One-year expectations kept rising alongside inflation readings and peaked with a peak in inflation. Thus, it is very possible that the 3-year expectation more accurately reflects sensitivity to the Fed’s actions where it counts: consumers.

Source: Federal Reserve Bank of New York, Survey of Consumer Expectations

I go into more detail about the mechanics of inflation expectations in “Inflation Expectations and Inflationary Psychology.”

Since short-term expectations can start to bleed into longer-term expectations for inflation, the Fed took a risk management approach when it finally got serious about inflation. Tamp down short-term expectations and remove the risk of perturbing longer-term expectations which could prove harder to control above recent historical ranges.

The Risk Management Approach to Monetary Policy

The question is not whether or not the Federal Reserve should have acted to normalize monetary policy (by picking a non-zero target). The question is how far does/did the Fed need to go. Powell made it abundantly clear that the uncertain (and unprecedented) economic environment put the Fed in a risk management framework. The Fed decided it could not manage policy to the average or expected outcomes in the economy.

For example, a year ago, during the Q&A at a Brookings Institution conference, Powell claimed that monetary policy must take into consideration tail risks and their costs. The Fed collectively had decided that the costs of high inflation outweighed the potential risks of expeditiously hiking rates. The economy has proven so resilient that economists have spent over a year and half pushing out forecasts for a recession, a recession that could have been the main transmission mechanism for monetary policy to tank prices. Now, with the market celebrating the end of rate hikes and declaring victory over inflation, the runway is clear for the soft-landing narrative. I suppose those folks who think the Fed had no influence over inflation will have to conclude that monetary policy is totally meaningless if a recession is not forthcoming!

Conclusion

The inflation debate will never end because participants often bring to the table strong assumptions about the Fed’s capabilities and over-confidence in understanding the intricacies of the post-pandemic economy.

Ultimately, I stand by my long-standing claim that the Federal Reserve acted too slowly as supported by later economic research that I covered last June in “Why Monetary Policy Was Late In Responding to the Pandemic-Era Inflation Surge.” I stake no claim on the ultimate target; I just claim that the Fed needed to start normalizing sooner given what could be known at the time about economic conditions and the massive monetary and fiscal stimulus in the economy. Stiglitz did not explicitly say that he would have preferred the Fed do nothing, but his stance implies as much and feeds the narratives that inflation was never a problem in the first place. Thus, the Fed cannot satisfy anyone, not the inflationistas like myself nor the disinflationistas like Stiglitz….and certainly not the deflationists who held sway for so long going into the pandemic.

Be careful out there!

The post Despite the Inflation Celebrations, the Case Against Team Transitory Still Stands appeared first on Inflation Watch.

Under Alan Greenspan, the Federal Reserve was known to stand on the sidelines while bubbles in asset prices grew and grew. Greenspan had a lot more faith in the Federal Reserve’s ability to mop up the subsequent mess caused by a bubble’s collapse than in its ability to stop a bubble, much less identify one.

It seems times have changed. On October 13, Businessweek chronicled the Fed’s efforts to make sure that soaring prices in agricultural land do not lead to another messy bubble and economic calamity. Prices have indeed soared across the midwestern United States:

“The Kansas City Fed reported land values were 20 percent higher than a year ago. The Chicago Fed reported a 17 percent increase in its district, the fastest increase since the 1970s. Nonirrigated farmland in the Minneapolis Fed district increased 22 percent in price.”

The factors driving these increases are the same as I reported from a related Planet Money piece: “Land prices have doubled in Iowa over the past few years“: “elevated crop prices, soaring farm income, and record-low interest rates.”

As a result, nervous regulators are demanding rigorous stress tests of banks up to their gills in agricultural loans. Businessweek also reports that regulators are “…scrutinizing the lending standards, loan documentation, and risk management at the country’s 2,144 agriculture banks.”

I will be very interested in the outcome of all this scrutiny. The same Federal Reserve that helped create record low interest rates is working to ameliorate the impact of those very same interest rates. This episode is a reminder that flooding an economy with liquidity does not produce equal outcomes for all sectors. Recovery and prosperity does not even need to appear in the sectors most impacted by the malaise the Federal Reserve scrambles to repair. Instead, the money tends to collect where it will generate the highest returns due to other economic factors. Currently, it seems that the bet is on farming. I believe the Federal Reserve was aiming for housing…

The post The Federal Reserve finally tries to fight a bubble…in the price of farmland appeared first on Inflation Watch.

Consider these statistics quoted from the article:

• Sales of new cars rose 11 percent, to around 11.4 million, in 2010 and are off to an even stronger start this year.
• More than 859,000 new cars were sold to consumers with a so-called subprime credit rating in 2010, a nearly 60 percent increase from the year before.
• [The packaged consumer loan] market stood at $36 billion in 2008, during the throes of the crisis, but by 2010 it had bounced back to almost $58 billion. Bankers and analysts project that could rise by as much as 15 percent in 2011.
• Over all, lending to subprime borrowers has risen to about 38 percent of the auto finance market, although it is still well below its precrisis highs when it made up nearly half of all loans.

As the NYTimes notes, “…the gradual expansion of credit in virtually every area except real estate is an important sign that the American economy is returning to health.” So while an obsession with housing statistics can mire one in deflationary blues, so many other corners of the economy are flashing much different signals.

The post Automobile subprime lending jumps 60% in 2010 appeared first on Inflation Watch.

While this revival of largess may never trickle down toward the masses of unemployed and underpaid, it is once again difficult to imagine that deflation is an imminent threat when bankers are being restored to previous glory!

The post Financial industry continues reflation with increase in salary of Goldman’s CEO appeared first on Inflation Watch.

After reporting an incredible $10.6 billion in profits last year, Pandit was rewarded with a 75% pay hike. His base salary went from a mere $1 to a more appealing $1.75M. Pandit froze his salary at $1 in response to the severe recession that almost wiped out the bank before the U.S. government bailed it out.

More details in Bloomberg: “Citigroup Boosts Pandit’s Base Salary to $1.75 Million From $1.” This article also references the bonuses paid out to several other Citigroup executives.

The post Citigroup CEO Pandit sees his salary (re)inflate appeared first on Inflation Watch.

The post China Gets More Aggressive In Inflation Fight appeared first on Inflation Watch.

Starting in February EZ or Access checking accounts will be charged $7.50 a month unless they maintain a $1500 balance. The monthly fee used to be waived if customers set up direct deposit for paychecks–or had two automatic bill pays. “When I opened this account they told me it was going to be free. Then what happens a month later? I get charged about $7,” said Moussa Gueye of New Haven…. Citibank isn’t the first to raise fees. In June, Bank of America raised its monthly fee by $3.

The post Citibank to increase checking fees appeared first on Inflation Watch.