Today’s highly anticipated 1/4 point rate hike is too little to late, and amounts to the equivalent of the Fed’s partially closing the door well after the horse has left the barn. Monday’s .5% gain in the Personal Consumption Expenditure Index (the largest increase in 14 years) and today’s unexpected sharp decline in the Chicago Purchasing Manager’s Index (the biggest drop in 30 years), which included a sharp rise in its prices paid index (the highest percentage reporting higher prices in 16 years), continues to provide compelling evidence that the Fed is well behind an accelerating inflation curve in an already decelerating economy (stagflation).
The Fed, in its press release, continues the pretense that inflation is negligible, despite overwhelming evidence to the contrary. It also asserts, in what may well qualify as the grossest understatement in Fed history, that its current policy is “accommodative.” and providing “support” to the economy. If Alan Greenspan believes that an appropriate neutral Fed funds rate, given current economic conditions, is perhaps 4% (as he has stated), the longer he remains “accommodative” by keeping rates below that level, the higher that neutral level ultimately becomes. If he nudges interest rates up in quarter point increments, by the time rates get to 4%, the neutral rate will have risen, perhaps to 6%. If the Fed then proceeds in measured increments to 6%, by the time it achieves that goal, the neutral rate may have increased to 8%. Therefore, the current commitment to be measured when it comes to the pace of rate hikes assures that neutrality will never be achieved.
The reason for this is simple. The longer rates stay too low, the worse inflation gets, and the higher future interest rates will have to climb to contain it. Also, the longer the Fed keeps rates artificially low, the more floating-rate debt Americans will accumulate, and the greater the ultimate economic burden will be in servicing that debt. If the Fed’s measured approach is intended to spare the economy from dealing with the full impact of this burden today, it succeeds only at the expense of imposing a far greater burden tomorrow.
If the Fed believes that a 4% funds rate is appropriate, it should immediately raise rates to at least 6%, and let the economic chips fall where they may. In such a way, the Fed might get ahead of the inflation curve, and the U.S. dollar might at least retain some significant percentage of its value. The Fed’s current approach assures that the dollar’s decline will be anything but measured.