Written by Steven Hansen
This past week the Consumer Price Index hit 2.8 % year-over-year growth, the producer price final demand index rose to 3.1 % year-over-year, import prices were up 4.3 %, and the FOMC directed the federal funds rate to be increased a quarter point. And it seems like only yesterday that pundits were worried about deflation.
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Is the Federal Reserve behind the eight ball? The primary tool for controlling inflation is the federal funds rate – and common belief is that it can take a year or more for a fed funds rate change to affect the economy. According to the Federal Reserve:
Monetary policy also has an important influence on inflation. When the federal funds rate is reduced, the resulting stronger demand for goods and services tends to push wages and other costs higher, reflecting the greater demand for workers and materials that are necessary for production. In addition, policy actions can influence expectations about how the economy will perform in the future, including expectations for prices and wages, and those expectations can themselves directly influence current inflation.
The FOMC sets the target for the federal funds rate, and the Federal Reserve Bank of New York uses its open market operations to attempt to hit the target by buying or selling government securities.
The FOMC uses open market operations like an accelerator and brake pedal to influence economic performance. By targeting the federal funds rate, the FOMC seeks to provide the monetary stimulus needed for a healthy economy. After each FOMC meeting, the federal funds rate target is announced to the public.
Does the FOMC really watch core inflation in setting the federal funds rate (effective rate is the green line in the graph below)?
Historically the evidence is that the FOMC reacts more to the CPI – as there has been relatively little change in core inflation since the mid-1990s. Core inflation seems to the their report card on how well they are doing – but few want to know inflation numbers without energy and food as this is not the real world situation of inflation being experienced. Only a small majority of households see the inflation of the CPI. If you are retired, in good health, and have your home and car paid off – then you are likely seeing little inflation.
On the other hand, younger households which are still accumulating are likely experiencing a higher inflation rate. The CPI is a breadbasket – and the inflation you experience depends on:
- where you live (especially urban vs. rural),
- how much travelling / commuting is required,
- how much medical attention you require,
- and the breadbasket mix.
Source: BLS
The ultra-low fed funds rate since the Great Recession may have introducted unknown dynamics into the economy. New Normal inflation may be like a bucking bronco where movements are not anticipated.
Other Economic News this Week:
The Econintersect Economic Index for June 2018 improvement cycle continues and remains well into territory associated with normal expansions. There are continuing warning signs of consumer over-consumption, as well as a degrading relationship between retail sales and employment.
