Connect with us

Hi, what are you looking for?


Monetary Policy Remains Sufficiently Tight

Slowly but persistently, inflation is falling. The Bureau of Labor Statistics announced the Personal Consumption Expenditures Price Index (PCEPI) increased 0.2 percent in July. Over the past year, prices are up 3.3 percent overall and 4.2 percent excluding food and energy. The backwards-looking figures, however, don’t give us the best picture of where the economy is headed. Recent data show we’re finally winning the fight against dollar depreciation.

Averaging over the past five months, the PCEPI has grown at 2.16 percent annually. For three months and one month, the figures are 2.0 percent and 2.4 percent, respectively. The Federal Reserve’s inflation target is 2.0 percent. As William Luther recently argued, it looks like inflation is back on target.

Some members of the Federal Open Market Committee, which is responsible for setting the Fed’s interest rate target, want to hike rates further. They should reconsider. The current target range is 5.25-5.50 percent. Using the largest of the annualized inflation figures (2.4 percent), that translates to a real (inflation-adjusted) range of 2.85 to 3.10 percent. 

We need to compare the real federal funds rate target range to the natural rate of interest: the short-term price of capital consistent with maximum sustainable resource use. Economists at the New York Fed estimate the natural rate of interest is between 0.58 and 1.14 percent. Hence, the policy rate is significantly above the natural rate, suggesting monetary policy is already quite tight.

Monetary data confirm the contractionary state of Fed policy. The M2 money supply is shrinking at 3.89 percent annually, likely due to financial disintermediation. Broader monetary aggregates, which weight the components of the money supply by their liquidity, are also contracting. The Divisia figures for M3, M4 less Treasuries, and M4 with Treasuries are falling between 1.92 and 2.69 percent annually.

In theory, an average inflation target would require less-than-2-percent inflation for some time to offset the two years of more-than-2-percent inflation we just experienced. In practice, this will never happen. The Fed’s target is asymmetric: It’s willing to tolerate higher (even significantly higher) inflation, but not lower inflation. There is no returning to the pre-pandemic trend for the price level. We’re left with permanently higher prices. Hopefully, the Fed continues to bring inflation down gradually.

The current course-correction is encouraging, but we can only give the Fed so much credit. The central bank is to blame for the 40-year-high inflation, after all. Adopting the flexible average inflation target in August 2020 was a mistake. Because the target is asymmetric, there’s now more uncertainty in long-run forecasts of the purchasing power of the dollar, not less.

Enter Your Information Below To Receive Free Trading Ideas, Latest News And Articles.

    Your information is secure and your privacy is protected. By opting in you agree to receive emails from us. Remember that you can opt-out any time, we hate spam too!

    You May Also Like


    As a parent, grandparent, guardian, or even an aunt or uncle, you want the best for the children you love and take care of....


    While it remains to be seen if the Supreme Court will allow President Biden’s student loan forgiveness plan to move forward, borrowers may still...


    When we refer to your retirement number, most people think about how much money you need to save to meet your retirement goals. Having...


    Whether you’re just getting started on your financial journey or have already made significant progress, a financial professional can help. There are many different...

    Disclaimer:, its managers, its employees, and assigns (collectively “The Company”) do not make any guarantee or warranty about what is advertised above. Information provided by this website is for research purposes only and should not be considered as personalized financial advice. The Company is not affiliated with, nor does it receive compensation from, any specific security. The Company is not registered or licensed by any governing body in any jurisdiction to give investing advice or provide investment recommendation. Any investments recommended here should be taken into consideration only after consulting with your investment advisor and after reviewing the prospectus or financial statements of the company.

    Copyright © 2023