The Fed Should Take Credit and Go Home

If we could freeze time, a soft-landing is upon us.

Today’s jobs report was full of good news. The U.S. economy added 223k jobs in December. The employment-population ratio and the labor force participation rate both edged slightly higher (0.2 and 0.1 percentage points, respectively). We have the lowest unemployment rate in 50 years (3.5 percent). The broader U-6 measure of unemployment hit an all-time low of 6.5 percent.¹ Average hourly earnings are growing at 3.4 percent (December annualized), which means that the recent pattern of wage deceleration remains underway.² There is no evidence—none—of a wage-price spiral. The U.S. economy added 4.5 million jobs in 2022, its second best performance in decades (second only to 2021).

The economy is not overheating. The labor market is not overheating.

What we are witnessing is an economy that is finally shaking off what I previously referred to as the ‘growing pains’ associated with rapidly entering and then slowly emerging from a pandemic-induced global recession. As economist Arin Dube put it earlier today, the Fed appears to be misreading the situation. A “hot” labor market is not the driver of our lingering inflationary pressures. He’s cautioning the Fed against further tightening.

I think it’s the right message, but the Fed is still talking tough.

Take Credit and Go Home

Yesterday, Alan Blinder, former vice-chair of the Federal Reserve published this op-ed in the Wall Street Journal. The piece is titled What if Inflation Suddenly Dropped and No One Noticed? As a former central banker, Blinder isn’t sanguine about where things stand at the moment. But he calls attention to the fact that “inflation has slowed to a crawl.”

[I]nflation in the second half of the year [2022] has run vastly lower than in the first half. In fact—and this is astonishing—it’s almost back down to the Federal Reserve’s 2% target. Even more astonishing, hardly anyone seems to have noticed.

Why isn’t more being made of this? Blinder says it’s because of the near universal habit of reporting inflation on a year-over-year (12 month) basis. While that makes sense in “normal” times, Blinder says it isn’t the best guide for policy action today. Essentially, you have to take the growing pains into account and look through some of the more distant volatility.

Even though Blinder tells us that “today’s true inflation rate” is running at just 2.5 percent, he doesn’t think the Fed should declare victory and go home. That’s because core PCE is still running above target at 3.7 percent. So, he says, “the Fed’s fight against inflation isn’t over.”

But maybe, following his own logic, it should be.

Blinder describes a “stunning drop in inflation,” which began in July 2022. But here’s the thing. He doesn’t give the Fed credit for the rapid deceleration in inflation we saw in the second half of the year. He writes:

Was the rest of the stunning drop in inflation in 2022 due to the Fed’s interest-rate policy? Driving inflation down was certainly the central bank’s intent. But it defies credulity to think that interest-rate hikes that started only in March could have cut inflation appreciably by July. There is an argument that monetary policy works faster now than it used to—but not that fast.

What did change dramatically was the supply bottlenecks. Major contributors to inflation in 2021 and the first half of 2022, they are now mostly behind us.

Peering ahead, the bottlenecks almost certainly won’t return. Another energy shock can’t be ruled out but looks unlikely. And the anti-inflationary effects of the Fed’s monetary policy are yet to come.

This is consistent with what I have been arguing for months. With fiscal stimulus running off and supply chain bottlenecks easing, we were destined to see inflation come down. It would have come down even without the Fed’s historically aggressive rate hikes. So Blinder is telling us that the Fed doesn’t deserve credit for the stunning drop in inflation that we have witnessed since inflation peaked back in June.

If, as Blinder seems willing to accept, inflation continues to abate in the first half of 2023, then the Fed’s rate hikes will begin to bite when they may no longer be needed to stamp out any lingering inflation.

It’s an argument that justifies a Fed pause, even though Blinder doesn’t weigh in on what he thinks the Fed should do.

So at this point, the Federal Reserve doesn’t deserve credit for fixing anything, but you can’t really blame it for breaking anything either.³ I’d be happy to give them credit for nothing. Take credit and go home!

1. This is the broader measure of unemployment, often touted by progressives like Senator Bernie Sanders (I-VT). It includes which includes the unemployed, plus those marginally attached to the labor force, plus those working part time for economic reasons. It was above 10 percent when Sanders announced his 2016 presidential run in April 2015.

2. If wage growth simply plateaued at its December rate, it would be consistent—given productivity growth—with the Federal Reserve’s 2 percent inflation target.

3. OK, maybe housing.