The essence of the monetary policy is to avoid such a calamity by firmly anchoring inflation expectations and supporting economic activity along the path of potential (and noninflationary) growth set by the stock and quality of labor and physical capital.
But that, I fear, is not what we could be seeing in the months ahead.
America’s noninflationary growth potential, currently upgraded to an estimate of 1.8 percent, is exceeded by the actual economic growth of 2.2 percent in the first nine months of this year.
Survey evidence also shows a broad-based acceleration of economic activity in manufacturing and service sectors that is historically related with GDP growth in the range of 3.3 percent to 4.7 percent. President Donald Trump was probably referring to these correlations while he was touting his tax reform last Saturday as “one of the great Christmas gifts to middle-income people.”
Remarkably, the latest evidence on wages and consumer prices is not reflecting the increasing capacity pressures in labor and product markets. Modest gains in labor compensation are more than offset by a reviving productivity, resulting in a negative growth of unit labor costs and rising corporate profits. Similarly, the core rate of consumer price inflation has come down to 1.7 percent, after a long period of hovering around 2 percent.
Contrasting with this deceptively benign inflation picture are accelerating price pressures at producer levels. Last month, producer prices marked an annual increase of 3.1 percent, nearly triple the reading observed in November 2016.
That’s what is in the pipelines, with more of the rising price pressures coming on stream from tax cuts that could begin to boost purchasing power of households early next year.
The Fed, of course, knows all that. The question is how the nation’s monetary authorities are responding to what’s coming down the pike in the months ahead. The change of guard at the Fed should not be delaying that response, because monetary policy operates with notoriously long time-lags of at least several quarters.
Meanwhile, markets are not fooled by 0.25 percent rate hikes. They correctly don’t see that as a problem to a strengthening economy. Traders, helped by the Fed, are ignoring the regular doomsayers by holding the yield on the benchmark ten-year Treasury note roughly stable at about 2.35 percent and pushing the Dow to new heights.
Wall Street sees that the Fed is a friend that keeps expanding, rather than contracting, the money supply. At the end of last month, the Fed’s monetary base – called M0 and the right-hand side of the Fed’s balance sheet — was 10.6 percent above its level at the beginning of this year. Over that period, the Fed has added $376.1 billion of high-powered money to the U.S. economy, boosting the banking sector’s loanable funds by $266.2 billion to an astounding total of $2.2 trillion.
