Monetary Mission Impossible, Part 2

In Part 1 of  Monetary Mission Impossible, we displayed the wild ride of food and energy price indices over the last 40 months and their modulated but still severe spillover into the CPI. Since self-evidently the Fed can do nothing meaningful about globally-determined energy and food prices, the volatility of these items in the recent past provides pretty good evidence that the Fed’s blunt interest-rate pegging and bond-buying tools are not fit for purpose.

Well, that’s especially true if you take the 2.00% inflation target literally and propose to hit it in near-term time intervals, such as 1-2 years at most. That’s surely the modus operandi of the current Eccles Building crowd at ranges both above and below the target.

In the overshoot case they raised rates abruptly by 500 basis points during the last 17 months to bring inflation to heel, once they belatedly figured out that the 2021 and early 2022 CPI surge wasn’t transitory. And it was even more evident during the period between their formal adoption of the 2.00% inflation target in January 2012 and the pre-Covid peak at the end of 2019. During that undershoot interval they did not stop wringing their collective hands about missing the 2.00% target from below, and were not reluctant to keep policy tilted heavily toward ease in order to help close the gap.

Then again, what is the “science” that suggests these monetary targets are to be achieved to the second decimal place? For instance, between January 2012 and December 2020 there was no case for easy policy at all, if you measured inflation by the 16% trimmed mean CPI. During that period it posted at a 1.91% per annum increase (yellow line), and we’d hope that’s close enough for government work even at the paint-by-the-numbers Keynesian Fed.

As it happened, however, the Fed heads said ixnay to the yellow line and, instead, pounded the table in behalf of the blue line. That represents the PCE deflator in the graph below, which rose at a 1.32% per annum rate during the same eight year period. And clearly that was the shortest measuring stick in town, with the plain old headline CPI posting in-between at a 1.54% per annum rate.

The implication, of course, is that the FOMC viewed the 59 basis points per annum difference in the measured inflation rate between two arbitrarily constructed indices—that is, the yellow line versus the blue line—as meaningful to policy. In fact, they must have viewed it as crucial to their policy goals—otherwise they could have never justified holding interest rates to the zero bound as long as they did and pumping-up their balance sheet as far as they did.

Indeed, “lowflation” was the perennial excuse for easy money during the entirety of that eight year period. But where is the science that says, 2.00% inflation is some kind of elixir of prosperity, while 1.31% inflation is a disaster to be avoided at all hazards?

There is none, of course. The Fed heads have been counting angles on the head of a pin since the malefic team of Bernanke and Greenspan started running the printing press on overdrive after the dotcom crash.