Will the Fed Sit Tight—or Tighten Policy?

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The regular meeting of the Fed starts today. Tomorrow, the Fed will issue a press release, describing any actions it decides to take, and hold a press conference where the chair, Jerome Powell, will take questions.

The Fed’s policy has been very stimulative through the pandemic. But with the recent high inflation reports, the headlines are increasingly warning that the Fed risks an inflation breakout if it doesn’t tighten policy very soon. So far, the Fed has resisted such calls and doubled down on its determination to keep the pump primed until employment is all the way back to pre-pandemic levels. The drama this week will be whether the Fed sits tight or admits that inflation is rising and that the Fed needs to tighten.

Expect the Fed to Stay the Course

I fully expect the Fed to stay the course and keep policy stimulative. To understand why, let’s look at some details.

On a one-year basis, inflation is indeed high. On a two-year basis, which captures the downturn and the upturn, inflation is still in the normal range over the past decade. The one-year numbers are simply misleading. More, when we look at the scary numbers, if we take out a handful of outliers, those numbers look much less scary. I discussed this in some detail several days ago; as more data comes out, the story really hasn’t changed. When you dig in, on time frame and components, inflation is not nearly as bad as the headline numbers suggest.

And it appears to be easing, as expected. Lumber, in particular, has dropped in price in recent weeks, and supply crunches in other commodities are passing as well. Suppliers are catching up with demand, as expected in a capitalist system. While the backward-looking current numbers are bad, looking forward, many of the worst effects are likely to ease.

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