Will the Fed Wreck an Improving Economy?

Today on TAP: Both the inflation and the employment outlook continue to improve.

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Two recent official reports suggest that the economy continues to do well on both the jobs and inflation fronts.

Today’s report on the Consumer Price Index for March by the Bureau of Labor Statistics shows a continuing pattern of disinflation. Prices generally increased by just one-tenth of 1 percent in March over February. That’s an annualized inflation rate of just 1.2 percent, or well below the Fed’s own (unrealistically low) target of 2 percent. Food and energy prices both declined.

The only notable increase was in the BLS category of shelter, which includes both rental and owner-occupied housing. That increased in March by 0.6 percent over February.

But higher housing costs are the result of the Fed’s own interest rate policies, which make mortgages more costly and depress both sales of existing homes and new housing construction. That in turn throws more people back on the rental market, raising rents. If the Fed began cutting rather than raising rates, housing costs would subside.

More from Robert Kuttner

Meanwhile, the jobs front also looks excellent. Friday’s employment report shows that the economy is continuing to generate more jobs, though at a reduced rate. The other good news in the report is stunning.

Employment levels are now back to pre-pandemic levels for every major subgroup, and so is the rate of labor force participation. The overall rate of unemployment is just 3.5 percent. Black unemployment is at a historic low, and at 5 percent is well below a pernicious trend over the past several decades, where it lingers at twice the overall unemployment rate.

Normally, you might expect that near-full employment would produce wage pressures and drive inflation. But wage increases, of around 4 percent on an annual basis, have actually lagged the rate of inflation.

The reason for that wage moderation is not good news—the long-term weakening of the labor movement. And while there are some pockets of encouraging union organizing, it will be a long time before those gains translate into general wage pressures.

One other positive sign is reported labor shortages in some scattered sectors. That’s also good news, in that it will force employers to offer better wages for those jobs. But that will not translate into general wage-driven inflation.

Last June, Larry Summers predicted that it would take two years of 7.5 percent unemployment to bring inflation down to acceptable levels. This is a case of burning down the village in order to save it, except that the village is the entire economy. Once again, Summers has been revealed as profoundly misinformed.

Given the Fed’s previous rate hikes, coupled with normalization of supply chains (which has nothing to do with Fed policy), the economy is now on track toward low inflation coupled with close to full employment—the famous “soft landing.” If inflation is 3 percent rather than the Fed’s needlessly stringent target of 2 percent, that’s no big deal.

The question now is whether Fed Chair Jay Powell will have the sense to declare victory and call it a day. The next meeting of the Fed’s policy-setting Open Market Committee is May 2-3.

One member of the FOMC, Chicago Fed president and Obama alum Austan Goolsbee, has already signaled that it’s time for a pause in rate hikes. In remarks prepared for a speech to the Economic Club of Chicago, as reported by the Financial Times, Goolsbee warned, “Given how uncertainty abounds about where these financial headwinds are going, I think we need to be cautious … We should gather further data and be careful about raising rates too aggressively until we see how much work the headwinds are doing for us in getting down inflation.”

The shakiness of the banking industry, caused by a combination of weak Fed supervision and overly aggressive rate hikes, has put Powell on the defensive. Goolsbee’s remarks suggest the beginning of a long-overdue debate inside the Fed and the end of automatic deference to the hapless chairman.

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