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The Fed should take credit and go home

Today’s jobs report was full of good news. The US economy added 223,000 jobs in December. The employment-to-population ratio and the employment rate increased slightly (0.2 and 0.1 percentage points, respectively). We have the lowest unemployment rate in the last 50 years (3.5%). The broader measure of U-6 unemployment hit a record low of 6.5 percent. Average hourly earnings grow 3.4 percent (December annualized), meaning the recent pattern of salary deceleration keep going There is no evidence—none—of a wage-price spiral. The US economy added 4.5 million jobs in 2022, the second-best performance in decades (second only to 2021).

The economy is not overheating. The job market is not overheating.

What we are witnessing is an economy that is finally shaking off what I previously referred to as the “growing pains” associated with the rapid entry and then slow exit of a pandemic-induced global recession. As an economist Arin Dube Having said that earlier today, the Fed appears to be misreading the situation. A “hot” labor market is not the driver of our persistent inflationary pressures. He’s warning the Fed not to go too far.

I think it’s the right message, but the Fed is still speak loudly.

Alan Blinder, former vice chairman of the Federal Reserve, posted yesterday this opinion edition al Wall Street Journal. The piece is titled What if inflation suddenly fell and no one noticed? As a former central banker, Blinder is not optimistic about where things are right now. But he draws attention to the fact that “inflation has slowed to an increase”.

[I]inflation in the second half of the year [2022] has dropped much more than in the first half. In fact, and this is surprising, it has almost returned to the Federal Reserve’s 2% target. Even more amazing, hardly anyone seems to have noticed.

Why isn’t more of this done? Blinder says it’s because of the almost universal habit of reporting inflation annually (12 months). While this makes sense in “normal” times, Blinder says it’s not the best guide for political action today. Essentially, you have to factor in the growing pains and look through some of the more distant volatility.

While Blinder tells us that “the real inflation rate today” is just 2.5 percent, he doesn’t think the Fed should declare victory and go home. That’s because core PCE is still above the 3.7 percent target. So, he says, “the Fed’s fight against inflation is not over.”

But perhaps, by its own logic, it should be.

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Blinder describes a “stunning drop in inflation,” starting in July 2022. But here’s the thing. He doesn’t give the Fed credit for the rapid deceleration in inflation that we saw in the second half of the year. He writes:

Was the rest of the surprising drop in inflation in 2022 due to the Fed’s interest rate policy? Reducing inflation was undoubtedly the central bank’s intention. But it defies credulity to think that interest rate hikes that began only in March could have reduced inflation appreciably in July. There is an argument that monetary policy works faster than before, but not as fast.

What changed dramatically were supply bottlenecks. The main contributors to inflation in 2021 and the first half of 2022 are now mostly behind us.

Looking ahead, bottlenecks will almost certainly not return. Another energy shock cannot be ruled out, but it seems unlikely. And the anti-inflationary effects of the Fed’s monetary policy are yet to come.

This is consistent with what I have been arguing for months. With fiscal stimulus winding down and supply chain bottlenecks easing, we were bound to see inflation come down. I would have gone down even without the Fed’s historically aggressive rate hikes. So Blinder tells us that the Fed doesn’t deserve credit for the impressive drop in inflation we’ve witnessed since inflation peaked in June.

If, as Blinder seems willing to accept, inflation continues to decline through the first half of 2023, then Fed rate hikes will begin to bite when they may no longer be needed to eliminate lingering inflation.

It’s an argument that justifies a Fed pause, although Blinder doesn’t weigh in on what he thinks the Fed it should do.

So at this point, the Federal Reserve deserves no credit fixing anything, but you really can’t fault it breaking nothing either. I would be happy to give them credit for nothing. Take the credit and go home!


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