The Fed's false memory syndrome sparks recessions
As this week began, financial markets indicated that investors were regaining confidence in the economy. Now the markets are headed back down. This volatility is based on highly rational fears that the Federal Reserve will tank the economy.
Investors are hoping the Fed will stop raising the Federal Funds Rate, and hence interest rates overall, within a couple of months and then reverse course and start lowering rates later this year, thus stimulating the economy and ending the recession.
The optimists were not getting their cues from the Fed. Quite the contrary: "To be honest with you, I don't quite know why markets are so optimistic about inflation," San Francisco Fed president Mary Daly said after the Fed's meeting last month.
The demand for people to produce goods and services for one another is the Fed's bête noire. The Fed fears that the current low unemployment rate will raise the price of labor. That will cause prices to rise, the story goes, because businesses will have to pay workers higher wages, and the companies will have to increase prices to consumers to avoid taking a loss on what they produce. Economists call this wage-push inflation.
This scenario, however, ignores productivity gains. It also assumes that consumers will pay those higher prices. But will they? Monday's Wall Street Journal reports that Conagra, the maker of Hunt's ketchup and Slim Jim meat sticks, "said it is done boosting prices for now. Conagra's sales volumes fell 8.4% for the quarter ended Nov. 27, which the company attributed in part to shoppers recoiling from the price increases." The article also documents other price cuts on items such as chicken wings and beer.
What these products with stabilizing prices have in common is substitutability. Although we may like ketchup and Slim Jims, we can get by without them. Prices for necessities such as milk and eggs have proven stickier, but they too will get back to normal as supplies increase in response to steady demand and higher prices. We will probably end up with a higher normal price for those goods, at least for a while, but the Fed's policies should be based on inflation now, not inflation from a year ago.
That is not happening. Inflation has in fact returned to its pre-pandemic rate, wrote Alan Reynolds of the Cato Institute in a tweet earlier this week:
Fourth quarter CPI inflation was the lowest in two years (and the same as Q2-2019). It might prove informative if a reporter dared to mention that the next time any FOMC Fed official gives another speech about the necessity of raising interest rates to expedite recession.
Unfortunately, the Fed's institutional memory of prior bouts of inflation is in fact a false memory (at best), Reynolds notes:
A centerpiece of the Federal Reserve's favorite institutional self‐defense mechanisms has long been to rewrite the history of the 1970s as a contrast between "prematurely loosening" under Chairman [Arthur] Burns and "staying the course" under Chairman [Paul] Volcker[.] ... Volcker was, in fact, much quicker to cut rates in the 1980 and 1982 recessions than Burns was in 1975, and Volcker cut the funds rate more deeply (by 10 percentage points). Yet the useful mythology about "prematurely loosening in the seventies" (rather than 1980) still exerts mesmerizing influence on policymakers and their compliant media messengers.
The Fed's institutional memory wreaks continual damage on the nation's economy because central banks do not and cannot work as intended. The damage the Fed is doing by its suppression of voluntary economic activity, on top of the long-term destruction already inflicted by President Joe Biden and the Democrat-controlled Congress of the past two years, is incalculable.
At present, there is little cause for optimism about the U.S. economy. The Fed will bring on a recession because that is what its false memory tells it to do.
S.T. Karnick is a senior fellow and director of publications for The Heartland Institute, where he edits Heartland Daily News.
Image: Federal Reserve.