Government Low-Balls Inflation, Fed Promises ZIRP For Years

As you can see above, the CPI has been at or below an annual rate of 2.5% since 2011, according to the government statistics. But does this seem right to you? I expect not. This is because the prices for many things we consumers buy are rising much faster than the government’s estimates – and rising much faster than our wages are going up.

Other inflation indicators show a similar pattern. The Personal Consumption Expenditures Index (PCE) produced monthly by the US Bureau of Economic Analysis (BEA) – and which is the Fed’s favorite indicator – was also up only 1.2% over the last 12 months.

Here’s an interesting chart I ran across last week. It shows how much faster consumer prices are rising than our average incomes are increasing. I trust we can all relate to this chart.

This chart only shows income growth versus college costs, healthcare costs and housing costs. But a similar pattern exists among various other things we consume in our daily lives. It’s as if the government doesn’t want us to know the real rate of inflation. Yet we see it every day when we go to the grocery store, need healthcare or shop retail.

We’ve all known this for years. The question is, why does the government want us so ill-informed. I have a theory: The government knows its massive deficit spending is inherently inflationary over the long-term, but they (and I mean Democrats and Republicans alike) don’t want us to know that inflation is much higher than officially reported.

We do know, of course, but we continue to elect big spenders year after year. What else should we expect? But that’s a different discussion for another time; let’s move on.

Fed Remains Committed to Zero Interest Rates Indefinitely

I haven’t written much about the Fed this year because its policy has been pretty much a broken record. The Fed Open Market Committee (FOMC) held its last policy meeting of the year last week and as everyone expected, the Committee voted once again to leave its key interest rate near zero – ZIRP – Zero Interest Rate Policy. No surprise there.

What was interesting about this meeting were comments made by Fed Chairman Jerome Powell in his post-meeting press conference. Powell suggested the Fed is committed to keeping short-term interest rates near zero indefinitely and is prepared to keep them there until inflation rises back above 2%.

Chairman Powell suggested the Fed is willing to leave short-term rates near zero for several more years and pointed out it could take a very long time to get inflation back above 2% – the Fed’s now apparent threshold for raising interest rates again.

While Powell has been the most transparent and open Fed Chairman ever – with his detailed press conferences after every FOMC meeting – his candor about the Fed’s intentions last week was eye-opening.

Why The Fed Wants Inflation at 2% or Even Higher

As suggested above, the Fed has been mostly a broken record this year. The Fed Funds rate has been near zero all year, and policy statements have repeatedly said it should remain ‘zero-bound’ indefinitely. Nothing new there.

However, there has been one new wrinkle in the Fed’s policy guidance in the last half of this year. While the Fed has maintained for years that its goal for inflation was 2%, Chairman Powell indicated in late August that the Fed would be willing to tolerate inflation above its 2% target before it would consider raising interest rates.

Many Fed-watchers took that to mean the central bank might tolerate inflation rising to 2.5% or even a little higher before it would consider raising its key short-term interest rate. While this policy shift raised some eyebrows initially, the reality is inflation is far from 2% (currently at only 1.2%, as noted above), much less 2.5% or higher.

The question is: Why does the Fed believe 2-2.5% is the ideal inflation rate for the economy? The answer is not entirely clear. Let’s take a look at the Fed’s official answer to the question:

“The Federal Open Market Committee (FOMC) judges that inflation of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Federal Reserve’s mandate for maximum employment and price stability. When households and businesses can reasonably expect inflation to remain low and stable, they are able to make sound decisions regarding saving, borrowing, and investment, which contributes to a well-functioning economy.

For many years, inflation in the United States has run below the Federal Reserve’s 2 percent goal. It is understandable that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes.

At the same time, inflation that is too low can weaken the economy. When inflation runs well below its desired level, households and businesses will come to expect this over time, pushing expectations for inflation in the future below the Federal Reserve’s longer-run inflation goal. This can pull actual inflation even lower, resulting in a cycle of ever-lower inflation and inflation expectations.

If inflation expectations fall, interest rates would decline too. In turn, there would be less room to cut interest rates to boost employment during an economic downturn. Evidence from around the world suggests that once this problem sets in, it can be very difficult to overcome. To address this challenge, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation modestly above 2 percent for some time.

By seeking inflation that averages 2 percent over time, the FOMC will help to ensure longer-run inflation expectations remain well anchored at 2 percent.”

A Lame Justification For 2-2.5% Target Inflation Rate

First, my apologies for asking you to read several paragraphs of “Fed-speak.” Second, if you ask me, the Fed’s justification of 2-2.5% inflation is, well, lame to put it bluntly. The weakest assumption in the Fed’s argument above is in the third paragraph where they claim that if inflation is too low, it “can weaken the economy.” How? They don’t say exactly say – other than claiming low inflation can lead to even lower inflation.

Let me interpret: What the Fed means here is that central bankers around the world are deathly afraid of DEFLATION! They won’t admit it, of course. In fact, they don’t even use that word in their policy statements, and I’ve never seen the word used in their policy meeting minutes. It’s as if this a fundamental rule among central bankers that you never speak the word DEFLATION.

Why might this be? Because central bankers know their monetary policies are completely useless in a deflationary environment. And they know deflation can get out of hand. In my view, this explains why the Fed very much wants to avoid deflation at any cost. I believe it also explains why the FOMC chose to raise its official inflation target above 2% earlier this year.

In closing, I think we can all agree that the true rate of inflation is well above the published level of only 1.2%, especially as illustrated in the second chart in today’s letter. While the Fed may be intent on getting the published inflation rate above 2%, the government wants us to believe inflation is lower than it really is. I don’t expect this to change.

Merry Christmas & warmest holiday wishes,
Gary D. Halbert

© Halbert Wealth Management

© Halbert Wealth Management

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