Monetary policy

Time to stop rate hikes

Well, interest rates raised again in the name of inflation, this time in particular due to wage pressures and price increase in service sectors. In energy, housing, automobile and consumer spending, we see in the November economic data little inflation if not deflation on month over month basis. If the Fed is truly data dependent they should at least start to consider cutting rates. In opposite they continue the course of monetary tightening, in fact accelerating that process in verbal and in actions.

I think the Fed is trying to bias or lean toward the conservative side, i.e. willing to be wrong rather to over tighten than to do less. This might be a fear to be “wrong” again as they used to call the inflation we have experienced “transitory”, and a fear of losing credibility to fight inflation as a central bank.

I think such fear is groundless. First, since the pandemic, we have a year or two sheltered in place or worked from home, and therefore we have been less productive. The society has suffered huge loss. In monetary term, such loss should be reflected in our money such that it would have less purchasing power, so a one time inflation is a natural thing and that’s the way it should be.

Second, inflation has large dynamic period of more than a year, so the current inflation is still transitory and the Fed did nothing wrong to call it transitory at the first place. If anything to improve, they should have highlighted the lengthy duration of inflation dynamics in their communications.

I think the Fed in conducting their policy should reverse back to forward looking, not any more data dependent. Monetary policy works with long time lag and a proper and effective policy has to be forward looking. In control theory, control actions have to weigh more on future information than the current and past information for systems with large time delays, otherwise it will be hard to make the system stable.

The Fed should consider to adopt and implement the new monetary monetary framework where it aims inflation to be 1-3% over a PERIOD of time and allows inflation to be overshoot for some time. The new policy framework provides foundations to policy makers to make a case of stopping rate hikes to avoid an immediate economic recession. After a long time of suffering from the pandemic, the society needs and deserves to have a good economic growth to cheer for.