My morning takeaway….
Chairman of the Board of Governors of the Federal Reserve System, Jerome Powell, will face the U.S. Senate Committee on Banking, Housing and Urban Affairs this morning where he will present the Board’s semi-annual assessment of U.S. monetary policy. The Federal Open Market Committee meets in two weeks so I do not expect Mr Powell to get into too many specifics about what the fed funds rate will be at the end of the FOMC’s meeting.
Expectations are that the FOMC will vote to increase the fed funds rate, the overnight rate that banks assess each other when lending excess reserves. The current target range for the fed funds rate is between 4.50 percent and 4.75%. The conventional wisdom is that by increasing the overnight rate, the Board can best pursue one of its statutory mandates, stable prices.
The Board would like to get the inflation rate down to two percent, but according to its favorite inflation barometer, the personal consumption expenditures index, it has some work to do.
According to data from the U.S. Bureau of Economic Analysis, January 2023 saw year-over-year personal consumption increase by 5.4%, more than double the Federal Reserve’s inflation target. However, the year-over-year metric has fallen from 6.1% in October 2022.
Between December 2022 and January 2023, expenditures increased by 1.8% making up for decreases in consumption between October 2022 and November 2022 (-0.2%); and November 2022 and December 2022 (-0.1%).
Critics of Federal Reserve monetary policy are usually quick to point out that there is too much money sloshing around in the country’s monetary base; that a reduction in the base should lead to a reduction in inflation. The Federal Reserve may be giving critics what they are asking for. The monetary base (currency in circulation and bank reserves) has been falling along with the personal consumption and expenditures index.
In October 2022, total monetary base was $5,339.6 billion. By January 2023, the monetary base had fallen to $5,328.4 billion or .003%. I think that .003% is negligible, but the Federal Reserve would argue that it is a fall in the right direction.
While I believe that the FOMC will vote to raise rates, how much the rates increase by will be a decision driven by politics as it is by economics. The United States is entering the silly season of campaigning that runs up to the 2024 presidential election. As the expenditures stemming from President Biden’s infrastructure spending and financial support for Ukraine seep through the economy, the last thing the Administration wants to contend with is increased financial stress on American households. Mr Biden would prefer to see the Federal Reserve bring a pause to the inflation fight by the end of this spring, putting the pain into the past as soon as possible while crafting a narrative that places the full blame for inflation on the central bank.
For this reason, I would not be surprised to see a fifty-basis point increase in the fed funds rate with no more increases throughout the rest of the year. This way, the Federal Reserve meets market expectations of rates exceeding five percent by the end of the year, while the slowdown in economic activity erodes inflation.
7 March 2023
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