This is not your father’s inflation – Twin Cities

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Edward Lotterman

The Consumer Price Index for December is out. Media universally reported prices are 6.5% above a year earlier. That is true, but largely irrelevant in terms of current policy.

The actual index dropped slightly. More importantly, whether you annualize the last three, four or six months, the current rate of price increases is 1.9% a year.

That is half of the average over the 40 years since 1982, coincidentally the year Fed Chair Paul Volcker took his size-14 shoe off the monetary brake pedal. Also, this 1.9% is just under the Federal Reserve’s long-term inflation target. Its policymaking Open-Market Committee starts a two-day meeting on Jan. 31. What should they do? And what should the general public think?

Well, recent essays by Minneapolis Fed President Neel Kashkari are a good starting point. Kashkari is extremely bright, but he is not cursed with a Ph.D. in econ. So he can write well for the general public. Start with his “Why we missed on inflation, and policy implications going forward,” dated Jan. 4, on the Minneapolis Fed website, and ably summarized by New York Times economic reporter Jeanna Smialek that same week. Also consider Kashkari’s March 18 essay, “Update on Inflation and Monetary Policy,” also available on the Minneapolis Fed website.

The gist is that the Minneapolis Fed president acknowledges he initially underestimated the magnitude and duration of the inflation we have experienced. He describes how the situation we are in differs from bouts of inflation in the past in that we now face a combination of longer term consequences of extended low interest rates, but also short-term surge factors including supply chain jam-ups after COVID abated and demand spiked, now the war in Ukraine roiling energy and ag commodity flows.

He notes how usual analytical techniques used previously by economists in the Fed system, and elsewhere, are not well-suited to this complex challenge, and he proposes modifications in them going forward.

As for policy itself, three of his points are key: First, “In my view, however, it will be appropriate to continue to raise rates at least at the next few meetings until we are confident inflation has peaked.”

And, “… the second step of our inflation fighting process … will be pausing to let the tightening already done work its way through the economy.”

Finally, “consider cutting rates only once inflation is well on its way back down to 2 percent. The mistake the FOMC must avoid is to cut rates prematurely and then have inflation flare back up again.” That would be a costly error, so the move to cut rates should only be taken once we are convinced that we have truly defeated inflation.

So Kashkari’s pieces are enlightening. But are they important in the broader scope of affairs? Yes, and more than one might expect.

The Federal Open Market Committee that sets policies for the money supply, and hence for interest rates, is a strange and much misunderstood animal. It is headed by the chair of the Board of Governors, currently Jerome Powell, a Wall Street attorney with many years of experience in the U.S. Treasury and now the Federal Reserve. The other six governors also sit on the committee. They and the chair are appointed by presidents and confirmed by the Senate just as are cabinet officials, ambassadors and federal judges.

However, while these seven alone can decide on many Fed questions, including ones of regulating financial institutions, the FOMC includes presidents from the 12 Fed district banks. So there are 19 direct participants in any meeting. When it comes to an actual decision on policies, only five of these presidents vote.

There is an annual rotation and ones from the nine smallest banks only vote every third year. Kashkari always participates in FOMC meetings, but 2023 is a year in which he will cast votes, making his views on inflation doubly important.

The seven governors have adjacent offices in Washington, D.C. The district presidents are separated. They are hired by the boards of directors of each respective bank. The president and Senate have nothing to do with them. They all have their own research staff to advise them on policy matters.

There is a tradition, or ethic, that these 12 do not caucus separately, or lobby each other on monetary policy issues outside of FOMC meetings. But they do communicate their views to each other. This may be through writings, such as those of Kashkari. It may be through speeches. Messaging is often subtle.

One of their jobs is to “show the flag” across all states in their respective districts. So the Minneapolis president may speak to the Kiwanis Club of Ashland Wis., and then to the Montana Farm Bureau in Great Falls, Mont., two weeks later. Each president has a standardized stump speech, but a few sentences can be added, a few adjectives modified, and it becomes a memo to the other 11 presidents, the six governors and the chair, on what the speaker thinks should be done.

It will go right over the head of the local dignitaries polishing off their rubber chicken, but a message will get through. That is why local stringers for the Wall Street Journal and the Associated Press will show up at virtually every public talk given by a Fed president in the year they vote. It is really not all that different from Winston Churchill describing the “iron curtain” that was “descending across Europe” in a speech at an obscure college in Missouri, or George Marshall setting out his plan for U.S. economic assistance to rebuild Europe in a commencement address. So articles on the local Fed website get more attention than you might think — and influence policy that will affect all our economic lives.

I think Kashkari is basically right on strategy for the coming months. There are other important related issues, especially what is happening to wages relative to balancing consumer prices with filling vacant jobs. The Minnesota Department of Employment and Economic Development this past week published research on historic rates of wage increases and how these compare with inflation, as well as on how wages are distributed from low-income to high-income Minnesotans.

Moreover — how, exactly, the Fed will reverse the huge jump in the money supply it made in response to COVID is a vital but ignored issue. These are important but must wait for future columns.

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