Wonking Out: How Low Must Inflation Go?

As I pointed out in my latest column, the politics of inflation are dominated by concerns about gasoline and food prices — precisely the prices over which policymakers in general, and the president in particular, have the least influence. Economists, by contrast, usually focus on measures that try to get at underlying inflation, excluding highly volatile stuff like, well, energy and food.

Actually, the traditional definition of “core” inflation — the one usually used by the Federal Reserve — which excludes only energy and food, has been problematic in the post-pandemic era. Why? Because we’ve been seeing some wild fluctuations in other prices, like used cars. So there’s growing emphasis on other measures of core inflation, like the Dallas Fed’s “trimmed mean” measure, which excludes extreme price movements in either direction. You can see the difference in this figure, which shows three-month rates of change in the two measures since 2020 (month to month is too noisy, whereas annual changes lag too far behind events):

Image
Not rotten at the core.
Credit…Federal Reserve Bank of Dallas, FRED
Not rotten at the core.

Traditional core inflation has been highly variable, the alternative measure less so. Both measures, however, have eased off lately. It looks as if underlying inflation is running at something like 3.5 to 4 percent.

Easing inflation is good. But we’re still well above 2 percent inflation, which the Fed and other central banks have traditionally seen as their target. And the Fed is set to continue tightening until that target is hit.

So why is 2 percent the target? I’m not going to crusade against the 2 percent solution. But anyone interested in economic policy should know that the history of how 2 percent came to define “price stability” is peculiar, and that the argument for keeping that target is grounded less in straightforward economics than in almost metaphysical concerns about credibility.

One way to see the peculiarity of 2 percent is to take a longer view of inflation, going back to 1984, the year of “morning in America.” At the time, the United States was experiencing rapid economic growth because the Fed, which had squeezed the economy extremely hard to end double-digit inflation, had relaxed monetary policy because, in its view, inflation had been vanquished. By 1984, and for the rest of the 1980s, the Fed felt comfortable about inflation because it was running at around only 4 percent:

Image
Memories of the Reagan administration.
Credit…Federal Reserve Bank of Dallas
Memories of the Reagan administration.

The point, of course, is that during Ronald Reagan’s second term, America’s underlying inflation rate was roughly what it is now. Yet policymakers were strutting around boasting about their victory over inflation, and the public didn’t see inflation as a major concern:

Image
4 percent used to be low enough.
Credit…Gallup
4 percent used to be low enough.

So how did 4 percent inflation come to be considered excessive and 2 percent acquire sacred status? It’s a long story, in which New Zealand, of all places, played a crucial role.

But the short answer is that 2 percent seemed to offer an easy answer to a dispute between economists who wanted true price stability — zero inflation — and those, including a guy named Larry Summers, who thought we needed somewhat positive inflation to preserve the Fed’s ability to fight recessions. The stable-price crowd was willing to believe that 2 percent was actually zero, because conventional inflation measures understated the benefits of technological progress. The room-to-act crowd believed that 2 percent was high enough that the Fed would rarely end up cutting interest rates all the way to zero and finding that it wasn’t enough.

As it turned out, however, this latter judgment was all wrong. The Fed and other central banks have spent much of the past 15 years with interest rates as low as they can go, desperately seeking other tools to stimulate their economies:

Image
But 2 percent wasn’t high enough.
Credit…FRED
But 2 percent wasn’t high enough.

As a result, a number of economists have suggested that the inflation target should be raised. For example, in 2010 Olivier Blanchard, then the chief economist of the International Monetary Fund, made the case for an inflation target as high as 4 percent. I made similar arguments to the European Central Bank a bit later.

None of these arguments got much real-world traction, however, perhaps because central bankers weren’t convinced that a higher inflation target would help them very much. But right now we face a different question: How much are we prepared to pay to get back to 2 percent?

Again, if the Fed were to apply the standards that prevailed in the 1980s, it would consider the current rate of inflation acceptable and declare victory. Instead, it’s putting a squeeze on credit markets and risking at least a mild recession to get us down to 2 percent from 4 percent. Why? It’s not because there’s a compelling economic case. As Blanchard and his co-authors asked back in 2010, “Are the net costs of inflation much higher at, say, 4 percent than at 2 percent?” There’s no real evidence to that effect.

As best I can tell, the main reason Fed officials are insistent on getting back to 2 percent is concern about credibility. They fear that if they ease off at, say, 3 percent inflation, markets and the public will wonder whether they will eventually accept 4 percent, then 5 percent and so on. One reassuring aspect of the current bout of rising prices is that longer-term inflation expectations have remained “anchored,” so that there are no signs of a 1970s-type wage-price spiral. Giving up on the 2 percent target might risk losing this anchor.

Being honest, if I were a decision maker at the Fed, I would probably have the same concerns. But it seems important to realize that if we are about to have a recession, which is certainly possible, it won’t be because hard economic considerations require that we squeeze inflation all the way back down to 2 percent. What we’re seeing instead is monetary policy driven by softer, vaguer concerns about credibility. We live in peculiar times.

The END GAME for the Dollar: China vs the U.S. | Grant Williams and Luke Gromen

In this episode of On The Margin Mike is joined by returning guests Grant Williams & Luke Gromen. We welcome back two financial market veterans for a special episode exploring the fracturing geopolitical landscape between the east and the west. Grant and Luke share their insight surrounding China’s declaration of war on the U.S, how the current monetary system could collapse China’s economy, the consequences of globalization, what the end game is for the dollar & how to prepare for the changing world order as two global superpowers collide.

Timestamp:

00:00introductions

00:55 ・ The great power competition: China vs U.S

08:39 ・ Is it ethical to be in business with China?

18:44 ・ The consequences of globalization

20:11 ・ A battle of ideologies between the east and the west

24:51 ・ The current structure of the monetary system

31:30 ・ Inflation is the only way out of a sovereign debt crisis

31:30 ・ Emblematic of moral decay

49:38 ・ Understanding the financial oppression

55:06 ・ Opinion on how Bitcoin plays in all this

 

 

Charlie Rose Interview with Sir James Goldsmith on Trade, 1994

Goldsmith warned elites about the dangers of free trade.

 

Timestamps:

00:00・Introduction

00:55・The great power competition: China vs U.S

08:37・The difference in financial markets between China & the U.S

18:42・The consequences of globalization

20:08・A battle of ideologies between the east and the west

24:48・The current structure of the monetary system

28:45・Coinbase Prime Ad

30:02・Ledger Ad

31:26・Inflation is the only way out of a sovereign debt crisis

36:52・The end of an empire

41:15・Financial repression

49:32・What assets to buy during financial repression

54:58・Grant & Luke’s framework for Bitcoin

China’s Stock Melt Down to Spill Over to the U.S. Economy, We’re on Monetary Heroin | Peter Grandich

Warning Sign:

Junk bonds are yielding less than CPI

 

 

people haven’t been making i never
thought i’d see this in my career
daniella the other day so-called junk
bonds or
yield bonds we’re yielding lower than
the cpi
index it’s just unbelievable that
something we used to call junk we know
right now
is going to pay us less than what the
current inflation rate is
i just don’t conceivably can’t bring
myself
uh to look at bonds in any way shape or
form
and quite frankly that’s a very scary
thing and maybe
i’ll end with this part the fixed income
market has been destroyed by the fed
and that’s the last part of my business
we i work with a group that specializes
in retirement and
business and exiting and estate planning
the retirement business is completely
up in the air there’s no longer any safe
secure
principle secured investment out there
people have to now take
risk to their principal in order to
maintain some sort of
you know financial stability retirement
whatever it may be
and that’s something we never thought
was going to be when we started
in this business and that’s the thing
that’s not being discussed by wall
street but will
when eventually the market implodes and
then people realize that hey what how do
i do how do i keep maintaining my
lifestyle
because i can’t i can’t keep making 5 10
or twenty percent like it’s
like it’s simple if i may one final note
it is an extreme pleasure and honor to
be interviewed by you
and your listeners are
don’t recognize how fortunate and
blessed they are
but because i know when i see you do
other interviews that you’re on the
other side of the coin or
who you’re interviewing but you don’t
attack them you give them a chance to
share their views and in a nice way
you bring up points that kind of point
out where they may not be
and i have to tell you that’s a blessing
and gift and i just hope you keep it
means a lot to me peter thank you so
much thank you for those words and
again thank you for your time come back
soon to stansberry investor.com okay

Anthony Pommpliano Calls Out Government Gaslighting over Inflation

They 100% lied about the inflation numbers in May. This is insane.

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Brent Johnson On Whether Inflation is Transitory or Enduring

In this episode of On the Margin, Brent Johnson of Santiago Capital discusses his views on whether or not CPI inflation is transitory or here to stay. We cover Brent’s view on the most recent CPI and PCE prints, why consumer prices are ticking up, and whether or not he thinks we are headed for inflation or deflation. We also did a review of Brent’s famous “dollar milkshake theory,” the impact of fiscal and monetary stimulus on the dollar, and why he believes a strong dollar is dangerous for global markets.

00:00 ・ Introductions

02:28 ・ Are we heading into deflation or inflation?

08:30 ・ How does QE play into the mix?

16:07 ・ How does supply/demand play into the mix?

25:20 ・ How do you predict inflation?

30:14 ・ Why is the strong dollar a problem for the world?

45:28 ・ What does a strong dollar do for stocks / US equities?

53:31 ・ The dollar’s international significance

58:52 ・ How to plan for a debt crisis