The current rate-tightening cycle is far from over.
On Wednesday, the Federal Open Market Committee, the Federal Reserve’s interest rate-setting body, will again raise rates aggressively, almost certainly by 75 basis points. Equally important, in its statement accompanying the rate-setting decision on Wednesday afternoon, the FOMC will likely signal that it will hike by an additional 75 basis points at its early November meeting, just a handful of days before the midterm elections.
The FOMC statement accompanying the rate hiking decision will contain few changes from the statement made in July when the Fed raised rates by 75 basis points. In July, the Fed said consumption and production “have softened” but that employment is robust and resilient. This time, the FOMC is likely to state explicitly that “inflation remains elevated.”
Critics of the Fed’s policy of continuing to raise rates aggressively note that headline inflation has peaked. These critics fret that aggressive Fed action raises significantly the risk of a deep recession where unemployment would rise substantially. But the Fed’s critics, economists identified with the progressive wing of the Democratic Party, are silent about the sticky components of inflation: wage inflation, up over 6%, shelter inflation, which the Dallas Fed said it sees peaking in the late spring, and services inflation, which the Dallas Fed said will continue to put upward pressure on overall inflation. The Dallas Fed explained that the tight labor market exerts upward pressure on demand for services, which tend to be labor-intensive. Finally, on the sticky components of inflation, the Dallas Fed said healthcare inflation is only now emerging. It noted that the pace of wage increases for healthcare workers is rising above 2%. The Dallas Fed said wage growth among hospital workers leads to PCE hospital services inflation and PCE healthcare inflation “by about one year.” The Dallas Fed further explained that healthcare inflation has a “disproportionate impact on PCE inflation,” the Fed’s preferred inflation metric.
It should be clear that Larry Summers and Jason Furman, two economists associated with the Democratic Party, are correct: The Fed must keep raising rates aggressively. Inflation is far from defeated. Summers went so far as to say that the Fed must keep raising rates until the Fed funds rate is above core inflation, which is running somewhere around 4.5-5%. And he opined that Fed policy must push the unemployment rate from its current very low level of 3.7% to over 5%. Such an increase would inflict pain on the economy.
In order to maintain its inflation-fighting credibility, the Fed must continue to raise rates, probably by another 250 basis points: 75 basis points this afternoon, another 75 in November, and an additional 100 basis points at the post-November Fed meetings. Hard economic times are coming, especially for the rate-sensitive sectors of the economy such as housing and for low-skill workers in the labor-intensive services sector.
High inflation distorts not only consumer behavior but also business behavior. Economic distortions cause productivity-sapping behavior. Consumers hoard, and business investment suffers.
The Fed will be aggressive until the labor market cracks. The Democratic Party better bundle up this winter.
James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on finance and the economy, politics, sociology, and criminal justice.
