Ron Insana says the Fed is defying logic by trying to create a recession

Federal Reserve Chairman Jerome Powell speaks at a news conference following a meeting of the Federal Open Market Committee May 4, 2022 in Washington, DC. Powell announced that the Federal Reserve is raising interest rates by half a percentage point to fight record-high inflation.

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Volcker or Vulcan?

Who should the Fed emulate today?

With a constant chorus of economists, ex-politicians and businessmen urging Federal Reserve Chair Jerome Powell to quell inflation now, they are panicking as if today’s inflation is exactly the same as what plagued the US economy over 40 years ago.

According to a well-known Vulcan, the comparison is illogical.

Powell almost admitted this on Wednesday, when he said some of the inflation currently being generated domestically and internationally is well beyond the Fed’s control.

I have argued that almost all of this is the case and that by aggressively tightening credit conditions, both through rate hikes and the introduction of quantitative tightening (QT), the Fed is overreacting to the long-term risk posed by short-term effects.

I have also argued that today’s inflation is more of a post-war phenomenon than a series of adverse shocks that hit the economy from the late 1960s to early 1980s.

At that point, then-Fed Chairman Paul Volcker issued record-breaking rate hikes that took short rates over 20% and long rates over 14%. This was a logical response to more than a decade of rising inflationary pressures, which was a multifactor phenomenon.

In my Volcker vs. Vulcan scenario, a more sober assessment of today’s inflation would attempt to measure risk versus reward and causality versus chance.

The ongoing nature of the pandemic, now largely affecting China’s economy and continuing to disrupt global supply chains far beyond what was once reasonably expected, is at the root of the elevated prices we are seeing today. This is primarily a question of Chinese domestic policy and secondarily a question of global economic and foreign policy.

In addition, the Russian invasion of Ukraine has unexpectedly and massively reduced the production of energy and food worldwide, causing another supply shock that has led to higher prices abroad and here at home.

This will not end until this war is over and it will not be resolved by any central bank.

Recently, American grocery bills have been found to be rising for meat and poultry as well.

It’s not just higher feed prices or fertilizer shortages that are driving up meat and vegetable prices – an outbreak of bird flu is reducing the supply of chickens, making even the cheapest meat substitute cheaper than just a few months ago.

And as for wage inflation, the Fed says labor costs are only rising in part because of increased demand for consumer goods and services.

Chairman Powell noted that there are currently 11.5 million job vacancies in the US, nearly double the number of unemployed — another shortage attributed at least in part to pandemic-related problems.

Against this backdrop, however, the Fed now appears poised to push the economy to the brink of recession and boost the unemployment rate to ease inflationary pressures, which I believe remain temporary in the broadest sense.

And I don’t think that these pressures will ease within a few months, but as in previous post-war periods, inflation falls as supply returns, even on the back of rising demand.

It is utterly illogical to think that aggressive tightening will shorten lockdowns in China, end the war in Ukraine, create over four million American workers from nothing, or even cure our chickens before they hatch.

I don’t know anyone other than St. Louis Fed President James Bullard who seriously believed the Fed would hike rates by 3/4 percent in this tightening cycle. As we saw on Thursday, the belief in relief was a fatally flawed construct.

While logic dictates that the Fed will gradually normalize rates and eventually reduce its balance sheet, it is becoming increasingly clear that the Fed intends to create a recession, not avoid it.

If I’m forced to choose between Volcker’s approach to today’s inflation or that of a Vulcan, I will choose Mr. Spock every time.

Volcker was justified in driving the economy into a deep downturn in 1980 to overcome embedded inflation, although these measures led to several negative events, such as the Latin American debt crisis, which ultimately forced him to reverse course and relax.

Logic dictates that the Fed won’t try that again, not today.

The economy is already starting to slow down. The dollar is rising fast and there will be a price for misidentifying the root cause of today’s economic problems.

The very notion of inducing a recession to reduce normalized demand to meet drastically reduced supply makes me raise an eyebrow and insist that “that is highly illogical, Captain.” Ron Insana says the Fed is defying logic by trying to create a recession

Jane Marczewski

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