Why Is the Fed Waiting For Inflation?

Popular Economics Weekly

The Federal Reserve should stick with a “wait-and-see monetary response” absent more evidence of sustainable inflation gripping the U.S. economy, Chicago Fed President Charles Evans said Tuesday. That seems to be Fed Chairwoman Yellen’s response to current world events, as well.

But what is ‘sustainable inflation’, really? It’s a code word for sustainable growth, as past history tells us we really need an inflation rate that is more than the Fed’s 2 percent target to achieve GDP growth that is sustainable.  And, as I said last week, though several of the Fed’s Open Market Committee are still pushing for higher interest rates, there is little sign of inflation at the wholesale or retail level, which means wages are not rising fast enough (that approx. 2/3rds of product costs) to boost consumer demand, and hence economic growth.

Evans — considered to be one of the policy panel’s doves but perhaps no longer an outlier with that view — said he’s willing to allow the U.S. economy to tip above the Fed’s roughly 2 percent inflation target to gain assurance that flares in inflation signals aren’t transitory, even masking economic trouble-spots that might benefit from a go-slow Fed. Factors dragging on growth potential right now include: weaker corporate spending, low commodities prices, China’s economic slowdown and market volatility, he told the City Club of Chicago.

There’s also the U.S. Dollar’s strength, which is harming our exports (read manufacturing sector) because it is in such demand as the world’s reserve currency and considered a safe haven for foreign investors that are leery of investing otherwise amidst the current geopolitical uncertainty.

And if the Fed does boost interest rates further than last December’s one quarter percent hike, it will boost the dollar’s value higher, thus making U.S. exports even less competitive in the current hyper-competitive world trade environment. Such a trade environment with low trade barriers means almost anyone anywhere can produce what is needed, resulting in a world awash in goods and services. The current oil glut is just one example that is depressing commodity prices.


Graph: Econoday

The good news is that manufacturing seems to be recovering, even with the strong dollar. The Philly Fed and Empire State manufacturing reports are the first positive signals of factory activity during the month. A look at February’s industrial indicators also show definitive evidence of recovery, says Econoday. The manufacturing component of the industrial production report posted a surprising 0.2 percent gain which came on top of January’s stunning gain of 0.5 percent.

Why the manufacturing pickup after 6 months of decline? The dollar is down a surprising 3.8 percent on the dollar index, making our exports less expensive to foreign customers. The above Econoday graph tracks the index value of the manufacturing component against monthly dollar totals for exports.

Exports have been sinking sharply for more than a year in what, by contrast, underscores the formidable strength of domestic demand. Yet the drop in the dollar has been accelerating. It is probably because the Fed’s Open Market Committee has been backing off its promise to raise short term rates as much as 4 times this year.

So we should listen to Fed Governor Evans. Higher inflation is necessary at his time and should be allowed, before the Fed raises rates further. Any sign that inflation could be a danger to growth would be almost instantly reflected by higher yields in the bond markets. And today’s US 10-year Treasury Bond is yielding an absurdly low 1.9 percent.

Harlan Green © 2016

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

About populareconomicsblog

Harlan Green is editor/publisher of PopularEconomics.com, and content provider of 3 weekly columns to various blogs--Popular Economics Weekly and The Huffington Post
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