Here is a simple question I can ask that may answer a lot of other questions about the Fed’s inflation target.
If the Fed undershoots its headline PCE inflation target by 50% or more for six years why have there been three rate hikes in total since 2015, and specifically why was there a hike in March 2017 and commencement of the chatter about unwinding the balance sheet after headline PCE rose to 2.1% yoy in February?
If the stated target, headline PCE, is symmetrical, none of this makes any sense because one would expect more passivity depending on how fast the symmetry is supposed to be accomplished. In a nutshell, it appears to me to be sort of hard to target a headline measure with any symmetry at all given the volatility in energy and food prices. Just think about how insanely hardcore and difficult to forecast it is. The only thing that would make it even close to workable as a matter of practicality is if it is a ceiling – see the target at 2% and it’s past time to do something – so need to do a lot.
That is the kind of behavior we’re seeing.
But here is another puzzle.
Since the election, everyone has gone long on the supply side promises made by the GOP and Trump specifically. It looked to me as if V had started to rise and, as a result, the Fed has made all sorts of plans to offset that rise, things that appear to me as completely ignoring the target because supply side changes shouldn’t cause any reaction at all. However, it is apparent now that much of the expected supply side reform will be slow in coming, taking an edge off the enthusiasm. Today, the possible outcome of the French election is looming large, and Trump appeared to have some impact on Forex by announcing that he believes that the dollar is too strong and the dollar weakened.
So the question is – what is the Fed going to do about these developments besides complain that the President is conducting monetary policy?
The Fed is full of people who only know how to tighten – because, as you know, fighting inflation is their entire reason for being. The Fed stamps it out, not causes it, hence, the headline target. They are the inflation-fighting hammers and everything that could cause a future PCE blip in the positive looks like a nail. They confirm their need for hammering by looking at last month’s reality which had a whole lot of nails. Today has even more things that may look like nails, even though the hopes of yesterday have faded into a sort of muddled reality. Not a positive thing – really.
My guess is that the Fed continues down the path of zigging instead of zagging because, as an institution, it only knows zigging. An anticipated further rise in V from weaker currency will be added to the things to be offset, and it will do more tightening, and do it faster as the economy gets weaker. It will do it because – and I am risking being politically incorrect here – unemployment doesn’t matter, inflation does, regardless of the source. If unemployment mattered, there would be rational target instead of the insanely hardcore headline target, and more behavior that could be described as rational at the Fed instead of nothing but hammers focused on pounding the daylights out of all those supply side nails.
Those who have learned nothing from history are bound to repeat it – and I am saying that that we need to buckle our seatbelts because the stubborn Fed learned nothing and has changed nothing about the behavior that caused so many problems in the recent past, and the die for what will happen next has likely already been cast.