The Fed can’t fix this

Given the state of the world, last week’s release of the report on consumer prices by the Bureau of Labor Statistics may seem to be of secondary importance, but still...

The report showed that prices for all items increased in March at a rate of 0.9 percent — the fastest monthly increase since the spike in monthly inflation rates we experienced during the COVID-19 period. On a year-over-year basis, the annual inflation rate for all items clocked in at 3.3 percent, well above the Fed’s inflation target of 2 percent.

Critically, these data reflect a backward view through the end of March. Formulating monetary policy, however, requires a forward-looking orientation. It’s not what has happened, so much as what’s likely to happen. While the Federal Reserve obviously pays close attention to inflation statistics as they’re collected and disseminated, the Fed is consistently faced with the question of whether the latest data reflect a link in a trend or an aberration likely to be reversed in coming months. These judgment calls are reviewed on an ongoing basis and adjusted as new data dictate. Complicating the Fed’s calculus is the fact that the economy is a complex organism with competing and contrary influences. The responsibility for our policymakers is to determine which of the competing influences is likely to be overriding.

As always, the Fed must balance its concerns about rising inflation with concerns about a weakening economy and rising unemployment. In the current situation, it seems likely that the weight of the data points to inflation being the larger problem for the Fed, at least in the near term. Thus far, the U.S. hasn’t experienced all that much of a slowdown, but much of the world hasn’t been so lucky, and their slower economic activity worldwide will likely have spillover effects for us, going forward.

The closing of the Strait of Hormuz and the destruction of energy-related infrastructure in proximity portend the persistence of elevated energy prices — if not higher energy price inflation. These forces are affecting the entire world and will likely continue to do so for as long as this waterway remains under Iranian control. And while a slowdown in overall economic activity worldwide will likely have a mitigating effect on inflation, it’s hard to imagine that the spike in energy prices wouldn’t have the greater influence on inflationary outcomes.

Looking at the CPI data more critically, we should realize that the Fed pays particular attention to consumer prices excluding food and energy, which it labels core inflation. This measure of inflation increased by only 0.2 percent in both February and March and 2.6 percent on a year-over-year basis by the end of March, as compared with 2.5 percent at the end of February. In isolation, these latest data signal only a slight worsening of the inflationary picture.

More likely than not, however, the Fed probably isn’t all that comforted by this measure’s slight increase. Usually, a lower weight is placed on food and energy prices because of a concern that too often, these price changes will be transitory. In the current circumstances, however, with the Strait of Hormuz being solidly under Iran’s control, discounting the rise in energy costs would seem to be inappropriate. Energy prices are likely to remain elevated for the foreseeable future with the consequence of elevating inflationary expectations. Inflationary expectations have a way of becoming self-fulfilling prophecies, and the Fed clearly wants to see these expectations contained. Given this assessment, any imminent easing of monetary policy and lower interest rates seem unlikely. In fact, by my reading, another round of interest rate increases should be expected from the Fed.

Of course, given our reliance on a narcissistic, ill-equipped, and unconstrained president guided by his gut and own sense of morality to navigate some kind of endgame in our war with Iran, who knows what can happen? We’re facing the possibility that inflation could end up being the least of our problems. But let there be no mistake: with Trump in the White House, our safety and security have been compromised and are currently in jeopardy of being degraded even more fully. Unfortunately, the Fed can’t fix this.