“Historically the Fed has a terrible record when forecasting growth and inflation. For instance, last December the Fed estimated growth for 2021 to be 4.2%. Just three months later, in March, it changed the forecast to 6.5% growth. By July it will raise that forecast to at least 8%” — Paul Ebeling
The Fed continues to say that the sharp rise in the inflation rate is temporary. Inflation will subside later this year, it says. As such it will keep interest rates near Zero and continue to gin the money supply by purchasing $120-B of bonds per month.
If the Fed is wrong, the US could see a runaway inflation problem that will be very painful to fix.
Fed Chairman Powell recently said, “We do expect that inflation will move up over the course of this year, and our best view is that the effect on inflation will be neither particularly large nor persistent.”
The consumer price index rose 0.6% in March (a 7.2% annualized rate), the largest month-on-month gainer since Y 2012.
In the last 12 months prices have risen 2.6%. That is already above the 2% Fed target. The 2.6% rate is low, mostly because the last 9 months of Y 2020 saw almost no inflation. Prior to the .6% increase in March, the January CPI rose .3% and in February it rose .4% There is a pattern here.
The Fed believes that the price increases are due to pent up demand, supply chain disruptions, and stagnant prices for the past few years. It believes that after the pent-up demand is exhausted and the supply chain disruptions fixed, inflation will fall back under 2%.
The inflation today is caused by more than just a pent-up demand and supply chain disruptions.
The reasons we have inflation are these: 1) rising energy prices, 2) a rapid growth in the money supply, 3) huge government budget deficits, and 4) a potential capital shortage. #4 is worrisome.
Inflation will likely not fall later this yr. In fact, it may increase so that we could be looking at double-digit inflation before Y 2022 begins. If that happens, the Fed will have to take drastic actions.
Inflation will likely increase because energy prices will continue to rise. That puts upward price pressure on most products, simply because manufacturing and transportation costs will rise.
Since the Biden administration has declared war on fossil fuels, the restriction in supply will keep prices rising as worldwide demand increases notes Economist Bruce WD Barren.
The Fed has no plans to stop increasing the money supply through its bond purchases. That means the money supply will continue to grow much faster than the economy. That will lead to pure inflation, regardless of what the misguided Modern Monetary Theorists say.
The Federal government’s budget deficit was more than $3 trillion last yr. This yr it will exceed that amount, and if Mr. Biden gets more spending bills passed, the deficit will get bigger. All of that excess demand will filter through the economy for this yr and yrs to come, putting upward pressure on prices across the board.
The Federal government is pulling trillions of dollars out of capital markets by selling bonds to finance the deficit leaving less capital available to business for expansion.
Mr. Biden also wants to 1) raise the capital gains tax rate from 20% or 23.8% now, to more than 40%, 2) raise the corporate tax rate from 21% to 28%, and 3) raise the personal tax rate on the highest earners from 36% to 39.6%.
Those tax policies will really reduce new capital formation, which will contribute to the capital shortage. Without capital, businesses cannot expand. They react to the increased demand by raising prices since the lack of capital means they cannot produce more. Because the returns on capital are already very high, there is a clear indication that capital is already in short supply.
Nothing is going to happen to reduce inflationary pressure, meaning inflation could hit double digits. If that happens the Fed will have to dramatically increase interest rates and reduce the growth of the money supply.
The Fed hopes those happenings will eliminate enough demand to bring inflation down. The danger is that if demand is reduced too much, a recession would follow. That is what happened in Y 1981.
The Fed should be concerned about inflation today. Interest should start to slowly rise and it should stop the explosive growth in the money supply. The longer the Fed waits, the worse things will get, count on it!
Have a healthy day, Keep the Faith!