Reassessing the Effectiveness and Transmission of Monetary Policy

Powell’s speech was on “Reassessing the Effectiveness and Transmission of Monetary Policy”.

Self-Serving Fed Nonsense

Powell had praise for how the Fed reduced inflation without bringing too much misery to unemployment.

Instead of blaming monetary and fiscal policy for inflation, Powell blamed supply chains and energy.

Undoubtedly supply chains and energy played a part, but the Fed kept a massive QE policy cranking despite the world’s largest stimulus in three rounds. The last round was the biggest and unwarranted.

At the end of the speech Powell gave a silly rant on the big role inflation expectations play, and that inflation was lower because people believed the Fed was credible.

Speech Quote Highlights

• It seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon. We do not seek or welcome further cooling in labor market conditions.
• The upside risks to inflation have diminished. And the downside risks to employment have increased. As we highlighted in our last FOMC statement, we are attentive to the risks to both sides of our dual mandate.
• We will do everything we can to support a strong labor market as we make further progress toward price stability. With an appropriate dialing back of policy restraint, there is good reason to think that the economy will get back to 2 percent inflation while maintaining a strong labor market.
• The initial burst of inflation was concentrated rather than broad based, with extremely large price increases for goods in short supply, such as motor vehicles. My colleagues and I judged at the outset that these pandemic-related factors would not be persistent and, thus, that the sudden rise in inflation was likely to pass through fairly quickly without the need for a monetary policy response—in short, that the inflation would be transitory. Standard thinking has long been that, as long as inflation expectations remain well anchored, it can be appropriate for central banks to look through a temporary rise in inflation.
• For a time, the data were consistent with the transitory hypothesis. 
• While researchers differ in their approaches and, to some extent, in their conclusions, a consensus seems to be emerging, which I see as attributing most of the rise in inflation to this collision. All told, the healing from pandemic distortions, our efforts to moderate aggregate demand, and the anchoring of expectations have worked together to put inflation on what increasingly appears to be a sustainable path to our 2 percent objective.
• Disinflation while preserving labor market strength is only possible with anchored inflation expectations, which reflect the public’s confidence that the central bank will bring about 2 percent inflation over time. That confidence has been built over decades and reinforced by our actions.
• That is my assessment of events. Your mileage may vary.

Market Friendly Accommodation

The Fed has clearly shifted to the jobs portion of its dial mandate letting inflation heal over time.

We already understood this to be the case from the Fed’s last FOMC meeting, but Powell emphasized that emphatically with his statement “We do not seek or welcome further cooling in labor market conditions.”

Inflation will take second position in the dual mandate. As long as people believe inflation will come in lower, it will. Yeah, right.

Your Mileage May Vary

Undoubtedly, “Your mileage may vary,” is the most accurate thing Powell said today.

Two Fed studies have debunked the myth of inflation expectations, and so does common sense. I have discussed this before but let’s go over it again.

Debate Over Inflation Expectations

I got into a debate with Bill Fleckenstein on Twitter over the silliness of it all. Curiously, he is a true believer.

My favorite quote from the Fed study.

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

I provided hard examples and a common sense analysis of CPI components.

I suggest you read the study.

— Mike "Mish" Shedlock (@MishGEA) November 28, 2023

Fleck dismissed the study without reading it.

Fleck: “The fed study? like they know anything. expectations impact behavior, it’s human nature, and it causes double ordering and ” buy in advance” at times.“

Me: “Bill, do you double up on rent? Food? Gasoline? Clothes? Natural Gas? Stoves, Refrigerators? What!”

Wonderful Bill.

What percent of the CPI are computer chips?

My rent and shoe analogies are only silly to those who fail to think properly.

It is precisely because expectations do not matter to so much of the CPI that inflation expectations do not fuel inflation!

— Mike "Mish" Shedlock (@MishGEA) November 28, 2023

Fleck : “First of all you cannot double up on rent”.

The irony of his comment is that it proves the point I was making.

Components of the CPI

(Click on image to enlarge)

By my calculation, at least 80 percent of the CPI is inelastic.

People will not double up on rent in advance if they think rent will go up. Similarly they will not double up on gasoline, medical operations, etc.

People can stock up on food, if they have a freezer, as I recommend. If so, they stock up on sales prices (i.e. the price has come down). People do not generally stock up at the highest prices expecting still higher prices. And where would they store it anyway? A freezer only holds so much.

Do people buy two cars if the price is going up? Take out extra prescriptions?

Everything Else

Please think about “Everything Else”.

That category includes refrigerators, TV,s, landscaping, vacations, etc., some of which are elastic demand items and some not. For example, you buy a refrigerator when you need one and then don’t ever double up no matter what your expectations.

Among elastic items, do people take two vacations this year and none the next if the cost will be higher next year?

So, expectation proponents, please tell me what the hell people will stock up on at high prices simply because they expect higher prices next year. Then tell me what percent of the CPI that is.

Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?)

I mentioned a Fed study and Fleck dismissed it out of hand immediately without reading. It is very much worth a look.

Please consider Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?)

Mainstream economics is replete with ideas that “everyone knows” to be true, but that are actually arrant nonsense.

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.

Finally, even if one is willing to entertain the idea that in some vague, mushy sense concern over costs and demand by individual firms facing fixed prices leads to a dependence of aggregate inflation on expected inflation, we are still left with the conclusion that short-run expectations should be the ones that are most important.

One might also be uneasy about policymakers’ relying too heavily on the assumption that inflation’s long-run trend will remain stable going forward so long as measured long-run inflation expectations do. Even if every one of my preceding arguments is judged by the reader to be completely unconvincing, it nevertheless remains the case that we have nothing better than circumstantial evidence for a relationship between long-run expected inflation and inflation’s longrun trend, and no evidence at all about what might be required to keep that trend fixed (beyond that it might involve keeping actual inflation from moving up too much above two percent on a sustained basis).

[Mish note: The last two paragraphs are a direct criticism of Fed policy as practiced by every Fed chair and people dismiss these reports without reading. The next paragraph is a hoot as well.]

Or would you justify the view that expectations “matter” by pointing to the inflation experience of the 1960s and 1970s, even though that period provides no actual evidence that workers or firms tried to boost their wages or raise their prices in anticipation of future price or cost changes?

The Fed study was not only accurate, it was funny, and replete with humorous quotes.

Amusing Quotes

• Expectations are by definition a force that that you intuitively feel must be ever present and very important but which somehow you are never allowed to observe directly: R. M. Solow (1979)
• Pure economics has a remarkable way of pulling rabbits out of a hat. It is fascinating to try to discover how the rabbits got in; for those of us who do not believe in magic must be convinced that they got in somehow: J. R. Hicks (1946)
• Don’t interfere with fairy tales if you want to live happily ever after: F. M. Fisher (1984)
• Few things are harder to put up with than the annoyance of a good example: Mark Twain, The Tragedy of Pudd’nhead Wilson (1894)

Do Inflation Expectations Matter?

I have discussed inflation expectations at least six times over the years.

My latest was on December 1, 2023: How Do Inflation Expectations Impact Wages and Future Consumer Inflation?

Inflation expectations cannot possibly matter much because 80 percent of the CPI is fixed demand and at least half of the rest turns out that way in practice.

The irony is Fleckenstein attacked a Fed study that was critical of the Fed without reading it despite the fact Fleckenstein is very critical of the Fed.

And amusingly, Fleckenstein places great faith in an easily debunked Fed hypothesis.

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