How the Fed Keeps Getting Inflation Wrong [View all]

https://prospect.org/blogs-and-newsletters/tap/2024-04-12-fed-keeps-getting-inflation-wrong/



President Biden made two catastrophically bad appointments. One was Attorney General Merrick Garland. The other was Fed Chair Powell. Either could literally cost Biden his presidency and the country its democracy—Garland by having slow-walked Trump’s prosecution and Powell by needlessly slowing the economy. The latest inflation report by the Bureau of Labor Statistics, released Wednesday, showed the Consumer Price Index ticking up by 0.4 percent in March, the same as in February, but slightly higher than expected. This in turn set off signals from the Fed that expected rate reductions would have to be postponed, and near-hysterical media commentary. The Dow duly dropped more than a thousand points.

According to one press report after another, the economy was stuck with high inflation; high interest rates would persist; and Biden’s election-year good-news economy would be stuck with a bad-news story. But if you bother to take a close look at the details of the actual price increases by sector, they have nothing to do with the kind of inflation that justifies high interest rates. Some of the Fed’s own research confirms that. Nearly all of the price hikes came from a few sectors, none of which have anything to do with overheated demand. Take homeowner insurance, where costs have soared, rising 20 percent between 2021 and 2023. That has everything to do with climate-related losses that insurance companies try to make up by hiking rates on other homeowners, and nothing to do with demand. High interest rates don’t touch that.

Likewise auto insurance rates, which increased a staggering 22.2 percent in 2023, according to the March CPI report. Why? Accidents rose during the pandemic, apparently because stressed drivers with cabin fever expressed their frustrations via road rage. More complex systems in cars also increased repair costs. The Fed’s policy can’t fix any of that either. A few outlier studies by economists at regional Fed banks confirm the errors in both the Fed’s analysis and its policies. This March report by two researchers at the San Francisco Fed, titled “What’s Driving Inflation?,” concludes that “current inflation is being driven almost entirely by services such as health care, transportation, accommodations, and housing rents.” People with spare purchasing power are not “demanding” more health care. Rather, the health system, including drug companies, has too much market power to rig prices.

Rather than hiking rates, the Fed should be pressing the Federal Trade Commission for even tougher antitrust enforcement. Some of the recent increase in the transportation sector is driven by idiosyncratic hikes in gasoline prices. For instance, California, with more than 27 million licensed drivers, experiences a more extreme version of the climate-friendly policy of requiring refiners to shift from “winter blend” to “summer blend” gasoline every spring. Because of transition costs, the current price of gas in California is about $5.43 a gallon for regular, or almost two bucks higher than the $3.63 average in the rest of the country, according to AAA. Powell’s high interest rates can’t fix that either. Nor can they solve the housing shortage. This is wonky stuff, but not that wonky. The media should be doing a better job of explaining it, as a counterweight to Powell’s bad instincts; and the economists in the Fed’s employ should be bolder about pointing out Powell’s bad economics.

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