Every economic recession in the entire post war period has been precipitated by the efforts of the Federal Reserve Board to curb and reverse accelerating inflation in the U.S. Historically, the Fed has been behind the curve during every period of economic overheating because the FOMC has always followed rising interest rates instead of getting out in front of them. As a result, in every instance, by the time monetary policy becomes restrictive the forces of inflation have become sufficiently entrenched so as to require an economic recession to break the momentum. Thus, the economy has never enjoyed a so-called soft landing.
Ironically, in the current situation, the FOMC claims that by “normalizing” interest rates before inflation builds up a head of steam, it will insure a long running economic expansion. Unfortunately, the FOMC’s focus on the currently low (3.7%) rate of unemployment has left it oblivious to a number of forces that are not only suppressing inflation, but in addition are already slowing the economy’s growth rate.
First of all, there is no such thing as wage push inflation. That is a totally fallacious concept. Inflation is always a monetary phenomenon, i.e. too much money chasing too few goods and services. Over the past year, Broad Money Supply (M2) has expanded at a 3.8% pace, well under the growth rate of nominal GDP at 5% plus. Together with the gradual shrinking of the Fed’s balance sheet, the increases in the Federal Funds rate, and tepid loan demand have all contributed to what is a mild liquidity squeeze, hardly a backdrop for accelerating inflation. Moreover, inflation is being restrained by various structural factors, including globalization, technological advances, intense competition by various disruptors, demographic factors and a strong U.S. Dollar, the latter in part a function of a rising Federal Funds rate.
Moreover, the economy is already slowing, e.g. housing and autos. The Trump tariffs are raising input costs in some industries, which will either be absorbed by companies, thereby inhibiting their growth or offset by raising taxes on consumers, neither of which can be constrained by a tighter monetary policy. An array of data from both industrialized and emerging economies indicate a global slowdown is underway. Of particular importance to the U.S. economy is the pronounced slowdown in China.
It would seem that today’s FOMC members believe they have learned from the Fed’s historical mistakes, but they are failing to understand that, “This time it really is different.” If the Fed continues on its current rate hiking path in a desire to build up the weaponry with which to combat the next cyclical downturn, it will only hasten its arrival.
