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Can the Federal Reserve have an impact on inflation?

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Yesterday’s conclusion of the June FOMC meeting was followed by a statement as well as a press conference by Chairman Powell. The overall message was that they acknowledge the pain that working Americans are experiencing as a direct result of inflation of over 8%. Secondly, they wanted to send a message that they are actively addressing that issue.

However, the message by the Federal Reserve and the reality that they face to effectively lessen the current rate of inflation is dramatically different.

Yesterday’s FOMC statement and information gleaned from Chairman Powell’s press conference acknowledge that the Federal Reserve needed a transformational change in its monetary policy and forward guidance. They also acknowledged facts that were obvious to economists and analysts but were omitted from former statements by the Federal Reserve.

The first acknowledgment was that the current level of inflation is persistent and not in any way transitory. Secondly, they acknowledged that the root cause of inflation; supply chain issues, cannot be impacted by rising interest rates. Most importantly, they acknowledge that it was not possible to gain any traction fighting inflation without taking the United States and the world into a recession.

Yesterday’s FOMC statement revealed the Federal Reserve’s current economic Outlook. The Outlook contains some dire predictions. It anticipates an economic contraction taking the GDP growth rate to 1.7% this year, and unemployment rising from 3.7% to 4.1% in 2024.

This brings us to the primary question that we address in the title of today’s article which is, can the Federal Reserve reduce the current level of inflation? Their goal is to impact the current core inflation which is at 6% to 2.2% by 2024. Furthermore, because they cannot address and impact inflation levels outside of the core levels i.e., food and energy costs, can they have any real impact and move inflation lower by simply raising interest rates?

The short answer is they cannot. Raising interest rates to levels above 5% is not feasible or sustainable on any long-term basis. The current forward guidance is anticipating that their fed funds interest rate target by 3 ½%, and higher in 2023. With a national budget deficit exceeding $25 trillion higher interest rates mean dramatically higher costs for the United States Treasury and servicing the interest on the national debt. This makes higher interest rates unsustainable for any long-term length of time.

Secondly, rising interest rates substantially over the next two years will have a profound impact on the economic Outlook leading the United States into a deep recession, which is also an unacceptable outcome to the forward guidance of the Federal Reserve.

Lastly, higher interest rates will not address the supply chain issues over which they have no control. These issues include the war in Ukraine and the lockdown in China due to increased cases of covid-19 which all lead to continued supply chain issues.

Effectively the picture painted by the Federal Reserve yesterday indicated that their forward guidance would result in an economic recession because of the contracting GDP and higher unemployment rate.

Although the Federal Reserve maintains that it is committed to moving levels of inflation back to its target level of 2% by 2024, they have very little control in achieving this goal. It is the supply chain issues that have been magnified by Russia’s invasion of Ukraine that need to un-wind naturally. Unless that happens, the Federal Reserve can have no major impact on inflation as it stands today and has the potential to cause more harm than good.

Wishing you is always good trading,

Gary S. Wagner - Executive Producer