The Fed Admits Inflation Mistake, then Repeats It – Peter Reagan

by Peter Reagan

KEY TAKEAWAYS

• The Fed recently cut interest rates despite high inflation, low unemployment and positive GDP numbers
• Fed Chair Powell cites “uncertainty” over the future as a major factor in the decision
• Economic uncertainty is a fact of life! But there’s an easy way to protect yourself financially…

Many people are wondering what in the world is going on with the Federal Reserve right now.

 

The general thinking over the last several decades is that one of the Fed’s primary jobs is to keep the economy running along like a well-oiled machine while keeping inflation from getting out of control (which, if you think about it, is a subtle nod to one of the biggest problems with a fiat money supply, but I digress…).

How does the Fed usually work its “magic” on the economy? Typically by adjusting interest rates –  in a nutshell, the Fed raises or lowers the cost of credit. Lower rates make borrowing and spending cheap, while higher interest rates discourage borrowing and encourage saving instead.

If the economy is not growing at a rate that the Fed likes, they’ll tend to lower interest rates. More borrowing, less saving, more spending – for households and businesses alike. Too much of this leads to an “overheating” economy, because more borrowing and spending means more competition for goods and services. Prices go up.

When that happens, the Fed raises interest rates to try to get inflation under control by making it more expensive to borrow money. Saving becomes more attractive than spending, economic activity slows and highly leveraged companies and households find themselves squeezed…

There’s a lot of argument over just how effective the Fed really is at managing the economy. (After all, central planning has never worked at a national level – ask the Soviets, or the Cubans, or the North Koreans!)

And when the Fed makes confusing choices, I really wonder what they think is going on…

What does the Fed think is going on with the economy?

Since Trump won the election, we’ve seen a lot of optimism! At the same time, no one other than the outgoing President seems to believe the economy is bursting at the seams thanks to massive growth.

With inflation significantly above the Fed’s 2% target and unemployment well under its long-term average, what should the Fed do? Seems obvious to me – raise interest rates, get inflation under control!

Right?

Well, as Alexandra Canal tells us, the latest CPI report rose 0.3% (up from 0.2% the month before) and the largest monthly gain since April. Annual CPI is officially 2.7%, another tick up from the previous 2.6% report.

…not too bad, you say? Well, core CPI (leaving out food and fuel prices, which do jump around a lot) came in at 3.3% – WAY above the Fed’s target.

Core CPI tends to be stickier than plain old CPI – a bumper crop of wheat or an OPEC meeting can have a huge, if temporary, impact on food and fuel prices.

Regardless, 3.3% is significantly higher than 2%. Right?

And what did the Fed actually do?

The Fed claim to be “data-dependent” (this seems to be Chairman Powell’s favorite phrase – and honestly it sounds a lot better than “transitory,” his previous favorite).

Here’s what the data say:

1. Core CPI: 3.3% (vs. Fed’s 2% target)
2. Unemployment: 4.2% (vs. long-term average 5.7%)
3. GDP growth: 3.1% as of the third quarter (vs. long-term average of 3%)

Inflation too high, unemployment low and GDP growth a smidge above average – should interest rates go up or down?

Surprise! Down.

In a split vote, the central bank voted to reduce its benchmark interest rate by 25 basis points to a new range of 4.25%-4.5%, initiating its third consecutive rate cut of 2024 despite signs that inflation isn’t entirely going away.

Not just down today, but they’ll keep going down (just not as much as speculators hoped):

The consensus among Fed officials is for two rate cuts next year, down from four previously forecast in September.

So, the Fed cut rates, again, and will keep cutting rates. But not as much as they originally planned…

So do they think that the economy is too weak? They must, right? They must believe that 3.7% inflation is the lesser of two evils.

Unless there’s something else they’re concerned about?

Jerome Powell explains himself

So what were they thinking? We have the answer from the horse’s mouth:

[Powell] acknowledged some uncertainty surrounding the effects the new policies of the Trump administration may have on the Fed’s rate path.

Some economists predict new trade, tariff, and immigration stances could be inflationary, posing new challenges for the central bank.

“We expect significant policy changes,” Powell said. “We need to see what they are and what effects they have. We will have a much clearer picture” once that happens.

The Fed, he added, is “thinking about these questions” but won’t have definitive answers for some time yet.

Translation: They don’t know what’s going to happen in the years ahead.

Surprise! Nobody else does, either.

The incoming Trump administration’s significant changes to tariff and tax policy alone will upset the status quo. Hopefully for the better – possibly for the worse.

So, maybe the Fed isn’t as concerned about inflation as they are about the economy… And that makes sense. Inflation punishes the working- and middle-class families the worst – while a broad economic downturn is bad for everyone. 

Yes, the Fed’s picking favorites. When you attempt to manage an economy from the top-down, there’s no way to get around that. The Fed makes choices that are helpful to some and harmful to others.

Do you have more to gain, or more to lose?

Let me level with you: Ultimately, no one can control something as big and complicated as the world’s largest economy. Not even the all-mighty Federal Reserve. They can certainly put a thumb on the scale. They can choose who wins and who loses.

But we can decide to opt out of their game.

You can’t control the national economy, but you can control your own personal economy! You can shelter your hard-earned purchasing power from the Fed’s policies and missteps.

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