The Federal Reserve’s inflation promises just don’t add up

Peter Morici is an economist and professor emeritus of business at the University of Maryland and a national columnist in the US.

With inflation high over the past 14 months, we can sadly conclude that it is entrenched, will be difficult to conquer, and is not just the province of the US Federal Reserve.

The current quagmire comes from both sides of the supply and demand scissor. Excessive Covid spending and the Federal Reserve’s money printing to finance the resulting federal deficits created too much liquidity chasing too few goods.

Pandemic relief sent money to people who needed help, but many who didn’t. Households and nonprofits have $3 trillion in savings and checking accounts that they didn’t have before the pandemic.

The Fed, by reducing its bond holdings by $47.5 billion monthly and $90 billion starting in September, is taking too long to suck all the excess liquidity out of the system.

Global and US supplies of what Americans buy have been reduced by an inadequate response to the consequences of climate change on global agriculture, Russian President Vladimir Putin’s Black Sea blockade on exports of food from Ukraine, Western sanctions reducing Russian oil exports, disruptions in global chip production, and ongoing global shipping and manufacturing disruptions due to Covid.

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Normally, higher interest rates would reduce auto sales and inspire automakers to offer deep discounts. But with continued chip shortages and reduced car production, new vehicles are terribly scarce and prices are booming.

The housing shortage was acute before the Fed started raising mortgage rates. Now, people who can’t afford it, are driving rents up at a breakneck speed.

Higher mortgage interest rates are limiting demand for new homes, but fewer will be built and the shortage will persist. Expensive rents allow builders and owners of existing homes to keep raising asking prices.

The cost of housing is about a third of the consumer price index. The longer inflation stays above 8%, the more likely it is that higher mortgage rates will have to reach 10% to break housing inflation.

Domestic drilling, at least so far, has been curtailed by the Biden administration’s leasing policies, higher federal royalty rates and subjecting refineries to tougher ethanol regulations. And government and industry scapegoats fear an adverse regulatory environment.

Vehicle manufacturers won’t offer most electric vehicles until the 2030s, and the average life of a new car is 12 years. Consequently, most vehicles on the road will be powered by oil until the late 2030s, longer if the auto industry can’t find enough lithium, and that’s proving a challenge.

Russia produced about 10 million barrels per day of oil in 2020. If Western sanctions cut sales and production by 30%, with the rest at a discount to China, India and other developing countries, that would around 3% of global demand. and increase prices by 30%.

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This combination of forces is enough to keep gasoline prices rising while maintaining Russia’s oil revenues.

A similar logic applies to Russian and Ukrainian grain, sunflower oil and fertilizer production; for example, the two countries account for 30% of world trade in wheat. Consequently, the US strategy of slowly squeezing Russia through sanctions and Russia’s control of Black Sea shipping is creating global food shortages.

Oil and gas are used to make fertilizers and process fresh produce such as canned tomatoes. Gasoline and diesel are needed to run farm equipment and move goods. Rising fertilizer prices will reduce, for example, rice harvests in Asia, further contributing to a price cycle of energy, fertilizer and food shortages.

Biden’s policies that reduce oil field activity limit US liquefied natural gas available for export to Europe as it replaces Russian gas. This will increase US heating bills this winter and the cost of almost everything Americans import from Europe.

The Netherlands is closing the Groningen gas field, which is the largest in Europe. As the Europeans phase out Russian gas entirely, American consumers will feel that pain as well.

The Fed’s efforts to reduce inflation to 2% are a fool’s errand unless the Biden administration and European leaders recognize the need for wartime policies of total energy production and take a more assertive stance on the Russian invasion, for example, by providing the Ukrainian Armies with offensive weapons and intelligence to attack Russia and break the Russian blockade with naval escorts for Ukrainian grain, sunflower and other food shipments.

The Fed forecast that it would raise rates to a peak of 3.8% in 2023 and reduce inflation to 2.2% in 2024 is hardly believable.

Together, housing, energy, food and new vehicles make up 58% of the CPI.

The Fed could reduce inflation to 2% by reducing price increases to zero in the other 42% of the economy. But the federal funds rate is high enough that to achieve this would surely throw the economy into a deep and prolonged recession.

Fed Chairman Jerome Powell simply needs a reversal of the Biden administration’s policies on oil and gas production and refining and a more assertive policy in Ukraine to have any hope of bringing inflation down to 2%.

This article was first published by MarketWatch, a title of the Dow Jones Group


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About the Author: Chaz Cutler

My name is Chasity. I love to follow the stock market and financial news!