Federal Reserve Chairman Jerome Powell recently promised economic pain in the Federal Reserve’s effort to reduce inflation and restore price stability, defined as 2% inflation over an economic cycle.
The Federal Open Market Committee, or FOMC, which sets monetary policy, will raise interest rates by 75 basis points on Wednesday. But it is a closely debated question whether the FOMC will increase interest rates by 75 basis points or just 50 basis points at its Dec. 14 meeting. Progressive politicians are beginning to whine about a too-aggressive pace of monetary policy tightening. Politicians on the Left are worried that further increases in interest rates will hit lower-income households hard.
ECONOMY AND INFLATION RANK AS TOP ISSUES IN RED-ZONE MIDTERM POLL
However, the most recent economic data are clear: Inflation is too high. The signs of falling inflation are almost imperceptible. The nonpartisan Congressional Budget Office says the secular growth rate of productivity in the United States is around 1.5%. But the latest and most authoritative information on wages in the U.S. comes from the Bureau of Labor Statistics, or BLS. According to the BLS, wage inflation was running at 5% as of Sept. 30. To reach the 2% inflation target, employment costs must fall from the current 5% pace to around 3.5%. Larry Summers and other eminent economists say that unemployment must rise before wage inflation will fall.
It is highly unlikely that wage inflation will fall dramatically between today and the Dec. 14 FOMC meeting. The labor market remains resilient. Weekly jobless claims, the best real-time measure of the state of the labor market, remain very low. According to the CME Group, Chicago Mercantile Exchange, “jobless claims remain steady and consistent with a tight labor market.” A tight labor market is not conducive to a slowing rate of wage inflation.
Other information also supports the view that the Federal Reserve remains far from reaching its 2% inflation target. Though households are being squeezed by inflation outpacing hourly wages, those same households have over $1.5 trillion in excess savings. This is partly thanks to the Biden administration’s embrace of modern monetary theory. Consumers are financing consumption from that surfeit of government transfer payments from the $1.9 trillion American Rescue Plan.
Commentary from U.S. businesses that rely on discretionary spending says that the U.S. consumer is still spending on services. The service sector continues to experience strong job growth and elevated wage levels. Services account for 70%-80% of economic activity in the U.S. To fulfill its duty to the public of maintaining low contained inflation, the FOMC will raise interest rates by 75 basis points at its Dec. 14 meeting. More economic pain is necessary. A pivot is not warranted.
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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.
