This is an excellent summary. One interesting question is the degree to which a decline in asset prices due to rate hikes will affect the real economy. I suspect that a prolonged decline in household wealth would be a significant cause of a cooling off of the economy and of inflation.
Regarding inflation let's not forget that most of the money issued to support the government stimulus during Covid is still sloshing around. That's why as soon as there is a small hope that inflation recedes, the stock market pops up like a whack-a-mole. And when the stock market goes up, automatically the financial conditions ease and that neuter the FED 's actions. I think the key in this problem is how the FED is going to withdraw all that money and bring its balance sheet to something more "normal".
A 2 per cent inflation target is a sure-fire recipe for hitting the Zero Lower Bound next time the economy turns down (which could be soon if the Fed misjudges the tightening). Need a 4 per cent target (possibly as part of a nominal income target). On that basis, there's no need to panic.
This post is a useful reminder that "economics" as a discipline is barely even a thing. Indeed, it may not be a thing at all, just math-infused jibber-jabber. If rocket scientists, brain surgeons, soybean farmers, or even just ordinary people driving to work were as bad at making predictions as "economists," we'd all be dead.
“Inflation hits everyone, while the unemployment from a recession hits only a few people.” I think that’s a great argument for inflation? Share the burden, don’t heap it on the poorest. Because those who will lose their jobs are predominantly the poorest already. Also missing the whole system effects such has reduced pay and pay stagnation for your middle income workers. It’s the same argument as why we locked down for the pandemic, it hurts everyone but we save the smaller group who would have died had we not shared the “cost”.
After the GFC everyone was banging on about the ZLB & secular stagnation etc and one idea I saw that made a lot of sense to me was that the 2% inflation target (& again, TARGET, not ceiling despite how many economic commentators and even central bankers talk) wasn’t bought down from Mt Sinai on Stone Tablets and was really just kind of arbitrarily chosen, so why not change the target to 4% & this would reduce the worries around the ZLB & the theoretical need for negative interest rates etc & all the other problems that caused, so why has all talk of shifting the target to 4% disappeared now when it would be much easier to bring it down to 4 than getting it up to 4 was then & would also reduce the amount of pain required to get back to target
“If you own a lot of stocks, you can’t be happy about what’s happened in the past five months or so.”
If you’re a long-term investor, you welcome the opportunity to purchase good stocks (some the best companies in the world) at significant discounts to 52-week highs. Christmas came early a few years ago when AAPL was 35% off its 52-week high, an overreaction to a dip in iPhone sales. Such clarity in a purchase decision is always welcome. A quick glance at a 20-year chart of the S&P 500 should put investors in a buying mood. Buffett also increased his AAPL position. As Buffett has written: “The stock market is a mechanism for transferring wealth from the impatient to the patient.” Indeed, “the stock market isn’t the economy.”
Noah, some points to note. The Fed's official target is not for core inflation, but overall inflation. Core inflation is instead used as an alternative measure to try and gauge which way future overall inflation may head. Getting even more granular, the Fed's target is based on the PCE Price Index (PCEPI), as opposed to the CPI.
On whether the Fed's previous rate hikes have had an impact, I believe we most certainly are seeing indicators that they are, and I would hasten to also mention that so too is their quantitative tightening.
In terms of where the impact is being seen, I highlight 1) the flatlining in the M2 money supply, which has not grown since December 2021, and 2) the impact of this showing up in durable goods prices, which clearly peaked in February 2022, and have decelerated sharply since.
In my view, the stagnation in M2 is the most critical factor that will result in inflation falling over time, with durable goods price moderation being the leading indicator of this impact. The key issue for the CPI/PCEPI moving forward is the lagging measurement of rental costs, which is likely to result in the CPI/PCEPI remaining artificially elevated, even as rising interest rates and a weakening economy have a disproportionate impact on the housing mark and rental prices, raising the risk of significant overtightening from the Fed and a severe recession down the road.
The Fed targets PCE inflation. It doesn't target core inflation. It uses core as an indicator of how broad inflation pressures are and to forecast future inflation. But the actual target is the overall inflation as measured by PCE.
Wages have risen about as much as CPI. I think the more interesting question is not price levels but price variance. That's the real trouble with high inflation.
I think what some of them are worried about is the cost of capital as interest rates rise and the impact that has on things like advertising budgets, electricity costs for running servers and capital costs of replacement parts and normal wear and tear on those servers. This is tangentially related to cryptocurrencies ability to delude themselves. As the cost of servicing capital increases the probability of those swimming naked being exposed increases also. Separately, I think Barry and Big Picture used to talk about this, what are the numbers for household debt, bank debt and business debt? Tech I think is still cash rich generally even if they are entering a period of higher servicing costs and lower ad spending but what do bank balance sheets look like and how are other companies asset to debt ratios? Those strike me as the most important questions as to whether when stuff blows up if it will be mild or an all out depression.
Noah, could you please help this non-economist understand why we expect inflation to drive stock prices down in nominal terms? Naively, it seems to me that this is double counting the impact, because inflation already erodes the value of a stock in real terms even at the same price. I understand the idea that inflation of consumer goods prices squeezes household budgets, erodes consumer purchasing power and lowers discretionary spending, which would hurt the stocks of companies that sell them. But why should this apply in an environment (like I believe we have now) of both wage and price inflation closely matched? I'm imagining a thought experiment of 1000% instantaneous inflation of both consumer goods prices and wages. Wouldn't that just be like adding an extra zero to everyone's paycheck and everyone's bills at the same time, but not changing the fundamental supply and demand?
Someone should tell Elon that worrying about deflation is like worrying about overpopulation on Mars
This is an excellent summary. One interesting question is the degree to which a decline in asset prices due to rate hikes will affect the real economy. I suspect that a prolonged decline in household wealth would be a significant cause of a cooling off of the economy and of inflation.
Regarding inflation let's not forget that most of the money issued to support the government stimulus during Covid is still sloshing around. That's why as soon as there is a small hope that inflation recedes, the stock market pops up like a whack-a-mole. And when the stock market goes up, automatically the financial conditions ease and that neuter the FED 's actions. I think the key in this problem is how the FED is going to withdraw all that money and bring its balance sheet to something more "normal".
A 2 per cent inflation target is a sure-fire recipe for hitting the Zero Lower Bound next time the economy turns down (which could be soon if the Fed misjudges the tightening). Need a 4 per cent target (possibly as part of a nominal income target). On that basis, there's no need to panic.
This post is a useful reminder that "economics" as a discipline is barely even a thing. Indeed, it may not be a thing at all, just math-infused jibber-jabber. If rocket scientists, brain surgeons, soybean farmers, or even just ordinary people driving to work were as bad at making predictions as "economists," we'd all be dead.
“Inflation hits everyone, while the unemployment from a recession hits only a few people.” I think that’s a great argument for inflation? Share the burden, don’t heap it on the poorest. Because those who will lose their jobs are predominantly the poorest already. Also missing the whole system effects such has reduced pay and pay stagnation for your middle income workers. It’s the same argument as why we locked down for the pandemic, it hurts everyone but we save the smaller group who would have died had we not shared the “cost”.
This results in weakening of currencies against the dollar. It means import led inflation occurs in these countries.
After the GFC everyone was banging on about the ZLB & secular stagnation etc and one idea I saw that made a lot of sense to me was that the 2% inflation target (& again, TARGET, not ceiling despite how many economic commentators and even central bankers talk) wasn’t bought down from Mt Sinai on Stone Tablets and was really just kind of arbitrarily chosen, so why not change the target to 4% & this would reduce the worries around the ZLB & the theoretical need for negative interest rates etc & all the other problems that caused, so why has all talk of shifting the target to 4% disappeared now when it would be much easier to bring it down to 4 than getting it up to 4 was then & would also reduce the amount of pain required to get back to target
“If you own a lot of stocks, you can’t be happy about what’s happened in the past five months or so.”
If you’re a long-term investor, you welcome the opportunity to purchase good stocks (some the best companies in the world) at significant discounts to 52-week highs. Christmas came early a few years ago when AAPL was 35% off its 52-week high, an overreaction to a dip in iPhone sales. Such clarity in a purchase decision is always welcome. A quick glance at a 20-year chart of the S&P 500 should put investors in a buying mood. Buffett also increased his AAPL position. As Buffett has written: “The stock market is a mechanism for transferring wealth from the impatient to the patient.” Indeed, “the stock market isn’t the economy.”
Noah, some points to note. The Fed's official target is not for core inflation, but overall inflation. Core inflation is instead used as an alternative measure to try and gauge which way future overall inflation may head. Getting even more granular, the Fed's target is based on the PCE Price Index (PCEPI), as opposed to the CPI.
On whether the Fed's previous rate hikes have had an impact, I believe we most certainly are seeing indicators that they are, and I would hasten to also mention that so too is their quantitative tightening.
In terms of where the impact is being seen, I highlight 1) the flatlining in the M2 money supply, which has not grown since December 2021, and 2) the impact of this showing up in durable goods prices, which clearly peaked in February 2022, and have decelerated sharply since.
In my view, the stagnation in M2 is the most critical factor that will result in inflation falling over time, with durable goods price moderation being the leading indicator of this impact. The key issue for the CPI/PCEPI moving forward is the lagging measurement of rental costs, which is likely to result in the CPI/PCEPI remaining artificially elevated, even as rising interest rates and a weakening economy have a disproportionate impact on the housing mark and rental prices, raising the risk of significant overtightening from the Fed and a severe recession down the road.
Great piece
https://www.federalreserve.gov/econres/feds/files/2022049pap.pdf
The Fed targets PCE inflation. It doesn't target core inflation. It uses core as an indicator of how broad inflation pressures are and to forecast future inflation. But the actual target is the overall inflation as measured by PCE.
Wages have risen about as much as CPI. I think the more interesting question is not price levels but price variance. That's the real trouble with high inflation.
I think what some of them are worried about is the cost of capital as interest rates rise and the impact that has on things like advertising budgets, electricity costs for running servers and capital costs of replacement parts and normal wear and tear on those servers. This is tangentially related to cryptocurrencies ability to delude themselves. As the cost of servicing capital increases the probability of those swimming naked being exposed increases also. Separately, I think Barry and Big Picture used to talk about this, what are the numbers for household debt, bank debt and business debt? Tech I think is still cash rich generally even if they are entering a period of higher servicing costs and lower ad spending but what do bank balance sheets look like and how are other companies asset to debt ratios? Those strike me as the most important questions as to whether when stuff blows up if it will be mild or an all out depression.
Noah, could you please help this non-economist understand why we expect inflation to drive stock prices down in nominal terms? Naively, it seems to me that this is double counting the impact, because inflation already erodes the value of a stock in real terms even at the same price. I understand the idea that inflation of consumer goods prices squeezes household budgets, erodes consumer purchasing power and lowers discretionary spending, which would hurt the stocks of companies that sell them. But why should this apply in an environment (like I believe we have now) of both wage and price inflation closely matched? I'm imagining a thought experiment of 1000% instantaneous inflation of both consumer goods prices and wages. Wouldn't that just be like adding an extra zero to everyone's paycheck and everyone's bills at the same time, but not changing the fundamental supply and demand?