December 17, 2021

At the Fed’s December FOMC meeting it  finally recognized that the economy is on solid footing and that the rising inflation rate may not, in fact, be as temporary as it thought previously.  It laid out a path of steady rate hikes over the next couple of years.  This is, in fact, a significant shift from the Fed’s currently ultra-easy monetary policy stance.  That is a good thing, but one wonders why it took Powell and his colleagues so long to reach that conclusion. Unfortunately, despite the rhetoric, Fed leaders expect monetary policy to remain accommodative through 2024.  By the end of 2024 – three years from now—it still expects the funds rate to be 2.1%.  That is almost one-half percentage point below the 2.5% rate that it believes constitutes a “neutral” policy stance.  At that point interest rates are neither stimulating nor retarding the pace of economic activity.  As a result, the inflation rate will remain far above its 2.0% target rate for years.  The Fed remains hopelessly behind the curve.  We are less than impressed.

At the post-FOMC meeting press conference Powell frequently referred to the strength of the economy.  “Economic activity is on track to expand at a robust pace this year.”  “The economy has been making rapid progress toward maximum employment.”

But the Fed still seems to believe that the inflation problem is largely temporary.  “While the drivers of higher inflation have been predominantly   connected to the dislocations caused by the pandemic, price increases have now spread to a broader range of goods and services.  Wages have also risen briskly but, thus far, wage growth has not been a major contributor to the elevated levels of inflation.”  In the Fed’s eyes, eliminating its asset purchases quickly and three 0.25% rate hikes next year will fix the problem and bring the inflation rate back to the 2.0% mark.

But, at the same time, the Fed expects GDP to grow 4.0% next year and the unemployment rate to dip to 3.5% and remain there through 2024.  The Fed believes that full employment is achieved when the unemployment rate reaches 4.0%.  Thus, the worker shortage will curtail GDP growth to 2.2% in 2023 and 2.0% in 2024.  The problem with that scenario is that the funds rate is expected to remain far below a neutral rate through 2024, thus the demand side of the economy will remain robust.  Against this background firms will need to offer steadily higher wages and better benefits to attract the workers they need.  That, in turn, will cause the inflation rate to remain elevated through the end of 2024.

To shrink inflation the Fed needs to bring the funds rate up to – or even perhaps above – a neutral rate of 2.5%.  The problem is that policy is so wildly stimulative at the moment that it will take a considerable amount of time to bring it back to neutral.  it plans to gradually “taper” its monthly asset purchases for the next several months and eliminate them entirely by March.  That means that the first rate hike will not occur until March.  It typically proceeds with one 0.25% rate hike per quarter.  Starting with a 0% funds rate and needing to get to the 2.5% mark will require 10 rate hikes.  With three rate hikes next  year, four in 2023, and three in 2024 it could get there by late 2024.  But the Fed does not plan to raise the funds rate beyond 2.1%.  How in the world does its described policy path bring the inflation rate down to its 2.0% target?  We do not think it will.

The Fed finally said all the right things about adjusting its policy to ensure that inflation does not get imbedded into wages and, therefore, become elevated on a permanent basis.  But its described policy path is inconsistent with a serious attempt to bring inflation under control.  That job may not begin until a new president takes office in January 2025.

With all major releases for November already having been released and the FOMC meeting behind us, this will be the last economic commentary until January.

Meanwhile, we hope that all of you enjoy this holiday season. Travel safely and stay healthy.

Stephen Slifer


Charleston, S.C.