Most of the coverage of Neel Kashkari's essay on inflation yesterday focused on the fact that he said he favored hiking rates all the way up to 5.4% (from 4.3% currently).
That, plus the rather hawkish Fed minutes, plus Esther George's comments on CNBC this morning--she's raised her forecast for rates, and sees the Fed hiking above 5% and staying there for some time--have all ruled out, for now, the possibility of a looming halt to rate hikes, which is pressuring stocks.
But to me, the most important thing in Kashkari's essay was his tacit acknowledgement that the massive inflation we've experienced was demand-driven, and thus, to put it differently, Fed (and government stimulus)-created. The reason he and other Fed members were so behind the curve in hiking rates in the first place was their insistence that inflation was "transitory," and mostly driven by supply shortages, and would therefore work itself out. Now, finally, comes the real story--that it was largely due to too much stimulus.
Kashkari doesn't quite put it that way, and may well take issue with my framing of it. But here is what he says in the essay, titled "Why We Missed On Inflation." He and much of the Fed were wrong, he writes, in "first, being surprised when inflation surged as much as it did, and second, assuming that inflation would fall quickly." Why were they wrong? He uses an Uber analogy to describe "a demand surge...[that] resemble[s] the economy we have been experiencing."
I wrote endlessly about this last year ("Still don't believe the Fed caused inflation?"), that no supply shortages would explain how the U.S. economy soared, in nominal terms, by 10% in 2021. But $10 trillion combined of Fed and fiscal stimulus would certainly help explain it. The problem was not that the Fed helped the economy in the depths of Covid. It was that they didn't remove stimulus quickly enough amid signs of overheating (from last March, "What if the Fed hiked by a full point?"). They let inflation out of the bag, and now have to slam the brakes as a result.
Kashkari says they didn't act sooner because (a) they thought the labor market would have to reach full employment first, and (b) long-run inflation expectations were relatively calm. The Fed's models didn't work, he admits! And here's the rub: they don't have new ones yet that work any better. They are using the same failed models to set policy now, a policy which now risks tightening too much and sending us into a needlessly deep recession. You can read more on these forecasting issues here: "Do you wait for the labor market to soften...or not?"
My point being, it's ironic that the market cares at all what Kashkari or any other Fed members say is now their "terminal" Fed funds rate, because he himself is admitting his information is no better, and possibly worse, than the market's. At some point, the Fed reacts to market conditions because they have to; and the lesson is not that they are pushed around by markets, but rather that they should have listened more seriously to certain financial market signals earlier on.
So yes, for now, the Fed is committed to hiking rates to over 5%. Unfortunately, they are still using unreliable models to do so.
See you at 1 p.m!
Kelly
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