Global Courant
The Federal Reserve’s decision to hold rates signals that central bankers feel it is time to pause, at least temporarily, in their aggressive campaign to curb runaway inflation.
However, the most recent data, not to mention several other factors, suggests that it’s time for a complete shutdown.
On June 14, 2023, the Fed chose not to raise the rates for the first time in 11 meetings, keeping the target interest rate – a measure of borrowing costs in the global economy – between 5% and 5.25%. Over 10 consecutive hikes from March 2022, the Fed had raised rates by as much as 5 percentage points.
“Holding the target range stable during this meeting will allow the committee to assess additional information and its implications for monetary policy,” the central bank said in a statement. The Fed gave in it still expects raise rates twice more by the end of the year.
like a economist following Following the central bank’s actions closely, I think there is good reason to believe that the Fed’s brief hiatus is likely to turn into a permanent vacation.
Inflation is lower than it seems
The highest inflation since the 1980s is what prompted the Fed to raise rates so sharply. So it makes sense that inflation would be an important indicator of when its job is done.
The most recent consumer price index data, published on June 13, showed core inflation – the Fed’s preferred measure, which excludes volatile food and energy prices – falling to an annual rate of 5.3% in May 2023, the lowest pace since November 2021. That is less than a peak of 6.6% in September 2022.
While the data shows that inflation is well above The target of the Fed of about 2%, there is good reason to believe it will continue to fall no matter what the Fed does.
Shelter, a measure of the cost of owning or renting a home, is the largest component of the consumer price index, accounting for more than a third of the total. In its latest report, the Bureau of Labor Statistics reported that housing costs are up 8% from a year ago. After we took that out, inflation was only 2.1% higher.
The thing is, the data reported by the agency doesn’t reflect the reality of what’s happening in the current housing market.
The Bureau of Labor Statistics is based on a survey which gauges rents from 50,000 leases, many of which were signed during the rental bubble in 2021 and 2022. A better measure of current market rents is the Zillow observed rent index. That index suggests that rates are falling – rents increased by 4.8% year over year in May, in line with pre-pandemic numbers.
Comparison of the two measurements suggests that the official consumer price index figures are four to six months behind the market. Using current rents would bring inflation much closer to where the Fed wants it.
Jason Furman, former chairman of the government’s Council of Economic Advisers, created a modified version of core inflation – which uses a market-based measure of shelter prices – at 2.6%.
Federal Reserve Chairman Jerome Powell wants to review the data before making his next move. Photo: AP via The Conversation /Jacquelyn Martin
The risk of more rate hikes
In addition, further rate hikes are likely to do more harm than good – particularly to the banking sector – and without helping to lower inflation below its current trajectory.
Several regional lenders, including Silicon Valley Bank and First Republic, collapsed earlier this year following bank runs. Combined they had more than half a trillion dollars in assets.
While there were several factors behind the banks’ demise, a major one was the Fed’s aggressive rate hikes, which drove down the value of many of their assets.
The banks catered to depositors with accounts that exceeded the $250,000 threshold, protected by the Federal Deposit Insurance Corporation. These depositors ran for the hills when they heard about the magnitude of bank losses.
This unrest, coupled with higher rates, also cools down activity. This means the Fed don’t have to leave as high on rates as it otherwise would have.
Further problems loom in the banking sector. Striking figures have appeared in the financial sector in recent days, such as Goldman Sachs CEO David Solomon and former US Treasury Secretary Larry Summersalmost warned that $1.5 trillion in commercial real estate loans will have to be refinanced over the next three years.
The combination of the already high interest rates and low office occupancy rate will likely force banks to absorb hundreds of billions of dollars in credit losses, inevitably pushing more banks to the brink of bankruptcy.
And if the Fed continues to raise rates, the situation is likely to get much worse.
Don’t make the same mistakes
The Fed fell behind the curve in 2021 and 2022 in realizing inflation was getting out of hand, and historically has been slow to recognize the impact of rents on inflation.
The June pause in rate hikes should give the Fed time to pause, look at the data, and realize, I hope, that inflation is closer to target than it appears.
But if it keeps raising rates, I think the central bank will repeat the same mistakes it made in the past.
Ryan Herzog is an associate professor of economics, Gonzaga University
This article has been republished from The conversation under a Creative Commons license. Read the original article.
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