Fed critics sound off on its disastrous inflation fight and obsession with a 2% target

Federal Reserve officials have dealt with their fair share of criticism from leading economists and business leaders for characterizing inflation as “transient” or temporary in 2021.

Key critics of Fed policy, such as former Treasury Secretary Larry Summers, argue that Jerome Powell’s loose monetary policies as Fed chairman, which were designed to rescue the economy from the COVID-induced slowdown in 2020, ended up exacerbating the crisis. inflation and increasing the risk of stagflation. instead of.

But in recent months, a new chorus of criticism of the Fed has emerged. One that argues that the central bank is now very focused on fighting inflation as it seeks to make up for past mistakes.

Fed officials raised interest rates at the fastest pace since the 1980s this year in hopes of bringing inflation down to its 2% target. (In fact, financial historian Adam Tooze thinks it’s the largest coordinated increase in interest rates in the history of the entire world.) But so far they’ve had little success. In September, inflation as measured by the consumer price index was close to a 40-year high of 8.2%.

Many high-ranking economists and business leaders think the index is wrong because they miss the signs that inflation is falling. They argue that the Fed is looking at old data that represents inflation in the economy from months ago, not what is happening on the ground today.

With stock market losses wiping out $9 trillion in American wealth so far this year, and global economic growth slowing, prominent economists like Claudia Sahm and William Spriggs and business leaders like billionaire Barry Sternlicht are worried the Fed could push the economy into a recession with its rate hikes.

“Your actions have already done enough to slow the economy. You can see it everywhere. Everyone sees. Except, apparently, the Fed,” said Sternlicht, CEO of private equity firm Starwood Capital Group. Fortune. “Your numbers are behind… This isn’t just the inflation that’s on the ground today. And destroying the economy because we are looking at stale data is repulsive.”

Sternlicht and other prominent Fed observers even argue that the Fed’s 2% inflation target is arbitrary.

“There is nothing written in stone that says inflation should be limited to 2%. This target was not the result of an economic model that says 2% inflation is ideal inflation,” Spriggs said. Fortune, adding that he believes he should not be the target given the current state of rapid technological and climate change.

“There are a number of reasons why holding on to these old notions is unwise,” he said.

The Fed’s 2% inflation target

The Federal Reserve has something called a dual mandate, which says its main job is to ensure maximum employment and maintain price stability.

To fulfill the second part of that mandate, the Fed “targets” an inflation rate of 2%. The central bank adopted an explicit 2% inflation target in January 2012, but the St. Louis, James Bullard, said there had been an “implied” inflation target of 2% since 1995. And, more recently, Fed officials decided to employ average inflation targeting, allowing more leeway around 2%.

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But critics say the target still doesn’t make sense.

“I think the number 2% is kind of arbitrary,” Sternlicht said. Fortune. “And could it be 3% or 4%? That would be good.”

Sternlicht, who has a net worth of $4.7 billion, believes that inflation is not the bogeyman that many economists make it out to be.

“There’s good inflation and bad inflation,” he said. “Inflation that is driven by wage growth is really what we want in this country. We want the less successful to participate in economic growth. Growth and inflation led by wage gains actually lead to a bigger economy, a bigger pie for everyone, because there is more consumption.”

Spriggs argued that the economy could “be at a higher level” if the Fed refocused on keeping as many jobs as possible. He likened the situation to a basketball game where a coach has to decide between playing fast (higher inflation) or slow (lower inflation).

“If the basketball team plays at full speed, these other players will come onto the court. We wouldn’t lose production. We ramp up production instead of squealing victory,” he said.

Lower inflation means a slower game where fewer people can play, according to Spriggs. In economic terms, this means less growth.

Sternlicht and Spriggs went on to argue that by trying to reduce inflation to 2% while Europe is in the midst of an energy crisis and the war in Ukraine continues, Fed officials will eventually cause a recession.

“There is no possibility that the American economy cannot avoid a recession next year now. Zero,” Sternlicht said.

Sternlicht also warned that in the long run, having such a low inflation target increases the risk that the Fed will “overdo it”, causing deflation – which can have devastating effects on economies.

“I think 2% as an artificial target might seem like a good number. But it’s so close to zero. And the problem is, as you go down to 2%, you can easily go down to minus 2%. You could enter a deflationary world where there is no demand and too many goods,” he said.

But there are many economists and business leaders, even progressives, who believe the Fed should keep its 2% target intact.

Brent Schutte, chief investment officer at Northwestern Mutual Wealth Management, considers himself in this camp, arguing that if inflation stays above the Fed’s 2% target for an extended period of time, it could lead to more volatile business cycles.

“If you let inflation heat up, you’re going to have to calm it down harder,” he said. “That leads to more erratic cycles, more ups and downs.”

George Ball, chairman of Sanders Morris Harris, a Houston-based investment firm with $4.9 billion in assets under management, went a step further, arguing that allowing inflation to remain elevated by more than 5% would be “a catastrophe.” comprehensive approach to the global economy. .”

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“I think society is better served by inflation rates that hover around 2% than anything that is appreciably higher. Inflation robs everyone, and particularly the poor,” Ball said. Fortune. “Two percent is a desirable and very healthy target if enough people believe that the Fed and the government will take strong enough action to achieve it.”

Ball went on to reference an analogy former Fed Chairman Paul Volcker used when they worked together at Prudential decades ago.

“The comparison he used was that fighting inflation is like killing a snake,” Ball said. “First you have to kill the snake, then cut off the snake’s head and show it to everyone in the community so they know the snake is dead.”

Claudia Sahm, founder of Sahm Consulting and a former Federal Reserve economist, also said she believes the Fed should stick to its 2% target.

“The Fed is not going to give up on its 2% target, and I think that’s appropriate,” she said. Fortune. “They took that as a target and said it would be a ‘job well done,’ so I think it would be upsetting for them to say, ‘Oh, actually, let’s redefine a job well done.’”

However, Sahm quickly added that the Fed has a choice when it comes to how fast they get back to 2%.

“There’s nothing in the Fed’s strategic plan that says they need to get to 2% next year, or two years,” she said.

Is the Fed overreacting?

Sahm believes Fed officials should pause their rate hikes, or at least delay them, and wait for the effects to ripple through the economy before deciding on their next move.

“What the Federal Reserve is doing now is causing an overshooting risk, that is, reducing inflation below 2%. They were so fast and so big that they are creating fragility in financial markets,” she said.

Sahm is one of a group of critics who note that the housing market is cooling, commodity prices are 20% below their highs and consumer inflation expectations have fallen to September 2021 levels, but Fed officials said that intend to continue raising interest rates.

Sternlicht argued that they are doing this because of their reliance on lagging inflation indicators. The billionaire, whose Starwood Property Trust owns about 250,000 residential units across the country, said officials should analyze “real-time data” and speak with business executives.

“All they have to do is call us, and all the other apartment owners, and we’ll tell them the rents are going down,” he said.

Sternlicht also noted that the Fed does not have the proper tools to deal with inflation. They can act to decrease consumer demand, but increasing the supply of goods and services is beyond their reach. He argued that the federal government could step in and help the situation by increasing legal immigration to increase the job market.

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Ball said the disagreement between economists, business leaders and the Fed over which policies are best for the US economy boils down to differing beliefs about “the greater good”. One side believes we should sacrifice jobs to fight inflation, while the other argues that jobs should take precedence even if the entire economy has to deal with persistent inflation.

He used the analogy of a commander on a battlefield to describe the difficult position the Fed finds itself in.

“It’s a classic trade-off between sending a battalion to be shot down so your army can win, or trying to somehow minimize troop losses while putting the army at greater risk,” he said.

A recipe for ‘social unrest’ and global recession

Over its history, the Federal Reserve has gone from taking into account the effects of its policies on other countries to essentially ignoring them, according to a 2013 document by the National Bureau of Economic Research.

This year, the central bank largely ignored the impact of its policies on other major and developing economies. Sahm says 2022 is a remarkably bad time to do this.

“The Federal Reserve is just making a very bad situation worse. They are making it much more difficult for developing countries to pay for food and energy because all these contracts are in dollars and many countries also have to maintain their debts in dollars,” Sahm said. “We have to recognize now that the global economy and financial markets are struggling and rate hikes are contributing to that. And that’s all the more reason for us to take a break, because if the global economy goes into recession, the US won’t be able to withstand the fall of the financial markets.”

Sternlicht was even more direct in his criticism, arguing that just when low-income Americans are finally seeing their wages rise, the Fed is hitting them “with a hammer right over the head.”

“I mean, this is a great solution, guys, congratulations. You performed a miracle,” Sternlicht said with sarcasm in his voice. “Isn’t the Fed’s job to control inflation and create full employment? Right now, they’re all about inflation, they can’t give a damn about the job.”

Sternlicht said he is “terrified” by what is to come for the US economy and fears that the repercussions of a severe Fed-induced recession could be devastating to more than just the economy, but the entire capitalist system.

“At the end of the day, the endgame here is social unrest,” Sternlicht said. “The rich person who loses 30% is still rich, right? But the poor guy who’s working by the hour and loses that job, he’s going to say, ‘Capitalism is broken; didn’t work for me. I lost my job. And this whole system has to go out the door. You will have social unrest. And it’s only because of Jay Powell and his merry band of lunatics.”

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