Powell July 27, 2022 FOMC Image

In Jackson Hole, Wyoming, Fed Chair Jerome Powell gave a hawkish speech today on Monetary Policy and Price Stability.

Key Highlights 

• Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance.
• Reducing inflation is likely to require a sustained period of below-trend growth.
• There will very likely be some softening of labor market conditions. 
• While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. A failure to restore price stability would mean far greater pain.
• The labor market is particularly strong, but it is clearly out of balance, with demand for workers substantially exceeding the supply of available workers. Inflation is running well above 2 percent, and high inflation has continued to spread through the economy. 
• While the lower inflation readings for July are welcome, a single month's improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.
• Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy. 
• The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.

Inflation Expectations Nonsense

Powell also gave praise to Ben Bernanke and totally disproved economic theory regarding inflation expectations.

The public's expectations about future inflation can play an important role in setting the path of inflation over time. Today, by many measures, longer-term inflation expectations appear to remain well anchored. That is broadly true of surveys of households, businesses, and forecasters, and of market-based measures as well. But that is not grounds for complacency, with inflation having run well above our goal for some time.

If the public expects that inflation will remain low and stable over time, then, absent major shocks, it likely will. 

Inflation Expectations are Crashing. So What? It Doesn't Matter.

Inflation expectations are a ridiculous concept. Two independent Fed research papers accurately make that conclusion. Fed studies also debunked the widely believe Phillips Curve.

Powell's comments are theoretically nonsense and actual Fed studies prove it. 

On August 8, I commented Inflation Expectations are Crashing. So What? It Doesn't Matter.

Please consider Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?) by the Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board.

Here are a few direct quotes. The last bullet point is the most important one.

• The direct evidence for an expected inflation channel was never very strong.
• It is an irony of history that, when Phelps and Friedman sought to justify their proposed theoretical specifications, they were faced with the uncomfortable fact that empirical Phillips curves appeared to be remarkably stable.
• These techniques are similar in spirit to those employed in the 1990s to estimate new-Keynesian models; hence, they suffer from the same sorts of problems—discussed below—that attend empirical estimates of those models.
• Friedman’s derivation of the expectations-augmented Phillips curve implies that the real product wage should be strongly countercyclical (recall that in this model firms are always assumed to be on their labor demand curves). In particular, Friedman states as a matter of fact that “. . . selling prices of products typically respond to an unanticipated rise in demand faster than prices of factors of production,” which would in turn imply the empirical prediction that the price Phillips curve is steeper than the wage Phillips curve. However, in U.S. data this prediction is completely at odds with the evidence.
• Most standard tests of the new-Keynesian Phillips curve suffer from such severe potential misspecification issues or such profound weak identification problems as to provide no evidence one way or the other regarding the importance of expectations (much the same statement applies to empirical tests that use survey measures of expected inflation).
• What little we know about firms’ price-setting behavior suggests that many tend to respond to cost increases only when they actually show up and are visible to their customers, rather than in a preemptive fashion. 

Fed Studies Debunk the Phillips Curve

• Fed Study Shows Phillips Curve Is Useless
• Yet Another Fed Study Concludes Phillips Curve is Nonsense.

Both studies were done by Fed staffers.

Yet, Fed Chairs Janet Yellen and Jerome Powell did not believe the Fed's own study.

If Inflation Expectations Mattered

If inflation expectations mattered, the above chart would not exist.

Let that sink in.

From 2013 to 2021 inflation expectations averaged well over three percent. Even with the Fed pumping hard with QE, the Fed could not get measured inflation over two percent!

How pathetic is that?

It's not really lack of inflation of course, but rather how senseless economists view it.

Factoring in home prices and asset bubbles there was massive inflation, just not where clueless economists wanted it.

Also consider A Fed Economist Concludes the Widely Believed Inflations Expectations Theory is Nonsense.

Here are some excerpts from the actual study:

The direct evidence for an expected inflation channel was never very strong. Most empirical tests concerned themselves with the proposition that there was no permanent Phillips curve tradeoff, in the sense that the coefficients on lagged inflation in an inflation equation summed to one.

In addition, most standard tests of the new-Keynesian Phillips curve suffer from such severe potential misspecification issues or such profound weak identification problems as to provide no evidence one way or the other regarding the importance of expectations (much the same statement applies to empirical tests that use survey measures of expected inflation).

What little we know about firms’ price-setting behavior suggests that many tend to respond to cost increases only when they actually show up and are visible to their customers, rather than in a preemptive fashion.

It is far, far better and much safer to have a firm anchor in nonsense than to put out on the troubled seas of thought. John Kenneth Galbraith (1958).

Few things are harder to put up with than the annoyance of a good example. Mark Twain, The Tragedy of Pudd’nhead Wilson (1894)

One should not need a study to prove the obvious. And it's obvious that inflation expectation theory is nonsensical.

The reason has to do with the way inflation is calculated. 

What Can the Fed Do About the Price of Food, Medicine, Gasoline, or Rent?

CPI Weights from BLS chart by Mish

On March 20, I asked What Can the Fed Do About the Price of Food, Medicine, Gasoline, or Rent?

What the Fed Can and Cannot Do

• The Fed cannot directly influence the price of anything because it cannot produce either goods or services.
• The Fed can reduce or increase demand where demand is elastic by raising or lowering the cost of money.

Elastic vs Inelastic Demand

• Elastic items total only 19.59%.
• Inelastic items total a whopping 80.41%.

This is why inflation Expectations theory the Fed abides by is total nonsense.

People will not rent two homes if they perceive prices will rise. Nor will people stop paying rent and wait for declines in they believe prices will fall.

The same applies to buying food, gas etc.

Stupidity Well Anchored: Absurdity of Inflation Expectations in Graphic Form

I discussed the silliness of inflations expectations theory in Stupidity Well Anchored: Absurdity of Inflation Expectations in Graphic Form

Asset Irony

People will rush to buy stocks in a bubble if they think prices will rise. They will hold off buying stocks if they expect prices will go down.

People will buy houses to rent or fix up if they think home prices will rise. They will hold off housing speculation if they expect prices will drop.

The very things where expectations do matter are the very things the Fed ignores.

Demand destruction will occur in the small subset of elastic items plus housing and stocks.

Except as related to recreation and eating out, rate hikes will not impact food, energy, or shelter, the overwhelming majority of the CPI.

Stupidity Still Well Anchored

Here we are with Powell, Barkin and other Fed presidents putting a spotlight on expectations, having ignored the third massive stock market bubble in just over 20 years.

Meanwhile, "there can be little doubt that poor people…are the chief sufferers of inflation."

Asset Irony

People will rush to buy stocks in a bubble if they think prices will rise. They will hold off buying stocks if they expect prices will go down.

People will buy houses to rent or fix up if they think home prices will rise. They will hold off housing speculation if they expect prices will drop.

The very things where expectations do matter are the very things the Fed ignores.

Demand destruction will occur in the small subset of elastic items plus housing and stocks.

Except as related to recreation and eating out, rate hikes will not impact food, energy, or shelter, the overwhelming majority of the CPI.

It seems crazy that economists cannot see the obvious, even when its pointed out repeatedly.

The reason is as noted above: "It is far, far better and much safer to have a firm anchor in nonsense than to put out on the troubled seas of thought. John Kenneth Galbraith (1958)."

One Agreement With Powell

I do have one key agreement with Powell, stressed repeatedly over the past six months.

On August 19, I repeated my message from earlier this year: Expect a Long Period of Weak Growth, Whether or Not It's Labeled Recession

Powell is in agreement "Reducing inflation is likely to require a sustained period of below-trend growth."

Yep, and it's started. We are likely in recession now, but label it however you like. 

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