[ It would be irresponsible to create much higher unemployment –
and the US economy could be pushed into recession. There is a strong
argument for the Fed to take a break from its aggressive
monetary-policy tightening.]
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THE FED SHOULD PAUSE INTEREST RATE RISES AS US INFLATION SLOWS  
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Joseph Stiglitz and Dean Baker
September 12, 2022
The Guardian
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_ It would be irresponsible to create much higher unemployment –
and the US economy could be pushed into recession. There is a strong
argument for the Fed to take a break from its aggressive
monetary-policy tightening. _

credit: ABC News,

 

The US Federal Reserve Board will meet again
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20-21 September, and while most analysts expect another big
interest-rate rise, there is a strong argument for the Fed to take a
break from its aggressive monetary-policy tightening. While its rate
increases so far have slowed the economy – most obviously
the housing sector
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their impact on inflation is far less certain.

Monetary policy typically affects economic performance with long and
variable lags, especially in times of upheaval. Given the depth of
geopolitical, financial and economic uncertainty – not least about
the future course of inflation – the Fed would be wise to pause its
rate rises until a more reliable assessment of the situation is
possible.

There are several reasons to hold off. The first is simply that
inflation has slowed sharply. Consumer price index (CPI) inflation –
the measure most relevant to households – was zero
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July, and it is likely to have been zero or even negative in August.
Similarly, the personal consumption expenditure (PCE) deflator –
another often-used measure based on GDP accounts – fell by 0.1%
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July.

Some will be tempted to credit tight monetary policy for this apparent
victory over inflation. But that argument commits the _post hoc ergo
propter hoc _fallacy (to assume that because A happened before B, A
must have caused B) and confuses correlation with
causation_._ Moreover, most of the main factors behind today’s
inflation have little to do with curbing demand. Supply-side
constraints drove inflation higher, and now supply-side factors are
bringing inflation back down.

To be sure, many economists (including some at the Fed) expected the
supply-side interruptions from Russia’s war in Ukraine and the
pandemic to be overcome _very _quickly. In the event, they were
wrong, but only about the speed at which conditions would normalise.
Much of this failure was understandable. Who would have thought that
America’s storied market economy would be so lacking in resilience?
Who could have foreseen that it would experience critical shortages
of baby formula
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feminine hygiene products
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the components
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to produce new cars? Is this the US or the Soviet Union in its dying
days?

Moreover, before Vladimir Putin started massing troops on the
Ukrainian border late last year, no one could have predicted that
there would be a major land war in Europe. And now no one can predict
how long the war will last, or how long it will take for political
leaders to stop the price spikes associated with it (some of which are
simply the result of price gouging – “war profiteering”).

Still, the overall inflation story is simple: Many of the supply-side
factors that drove prices higher earlier in the recovery are now being
reversed. Notably, the CPI gasoline index plunged by 7.7%
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July, and private indices suggest a comparable decline in August.
Again, this price reversal was predictable and predicted; the only
uncertainty concerned the timing.

Other prices are following a similar pattern. In July, the core CPI
(which excludes energy and food) rose by a relatively modest 0.3%
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deflator rose by just 0.1%
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That suggests an easing of the backlog of imported goods – the
problem behind those empty store shelves and business disruptions
earlier in the pandemic.

Recent data support this inference. The Federal Reserve Bank of New
York’s global supply chain pressure index
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fallen sharply from its peaks last fall to just above where it was
before the pandemic. While shipping costs are still well above
pre-Covid levels, they are down almost 50%
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last autumn’s peaks and likely to keep falling. After soaring during
the pandemic and in the early months of Russia’s war, the prices of
a wide range of commodities have fallen to pre-pandemic levels.
The Baltic dry goods index
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its average level for 2019.

Auto manufacturers have also overcome the problems created by the
worldwide semiconductor shortage. According to the Fed’s industrial
production index
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motor-vehicle output was actually above its pre-pandemic level as of
July.

After a year of getting a lot of bad news about inflation and the
supply-side factors behind it, we are starting to get a lot of good
news. And while no one would suggest monetary policymaking should rest
on just two months of data, it is worth noting that inflation
expectations have also moderated, with the University of Michigan
consumer sentiment index [[link removed]] and the New
York Fed’s survey of consumer expectations
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July.

The standard justification for Fed policy tightening is that it is
needed to prevent a cycle of self-fulfilling expectations, with
workers and businesses coming to expect higher inflation and setting
wages and prices accordingly. But this cannot happen when inflation
expectations are declining, as they are now.

Some analysts have suggested the US needs a long period of higher
unemployment
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get inflation back down to the Fed’s target level. But these
arguments are based on the standard Phillips curve models, and the
fact is that inflation has parted ways with the Phillips curve (which
assumes a straightforward inverse relationship between inflation and
unemployment). After all, the large rise in inflation last year was
not due to a sudden large drop in unemployment, and the recent
slowdown in wage and price growth cannot be explained by high
unemployment.

Given the latest data, it would be irresponsible for the Fed to create
much higher unemployment deliberately, owing to a blind faith in the
Phillips curve’s ongoing relevance. Policymaking is always conducted
under conditions of uncertainty, and the uncertainties are especially
large now. With inflation and inflationary expectations dampening, the
Fed should be assigning more weight to the downside risk of additional
tightening: namely, that it would push an already battered US economy
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should be enough reason for the Fed to take a break this month.

_[JOSEPH E STIGLITZ
[[link removed]] is a
Nobel laureate in economics, university professor at Columbia
University and a former chief economist of the World Bank.]_

* inflation
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* interest
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* interest rates
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* unemployment
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* Jobs
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* recession
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* Economy
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* monetary policy
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* Housing
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* prices
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