It’s Powell vs. Biden and the Winner is…

There is bad news coming from the battlefront. No, not the Ukraine-Russian front lines, where things seem to be going better than expected, at least for now. But from the battle between the Fed and the President. The Federal Reserve Board, fighting inflation, is hurling its fraction-of-one-per cent interest rate increases against the President’s trillions in new spending and loan forgiveness, and the inflationary effects of new restrictions on the development of the nation’s oil reserves. The result is an inflation rate that has investors rattled and consumers hurting.

Eating Gets More Costly

Consumer prices rose 8.3 per cent last month over a year earlier. For those who neither eat nor drive nor light nor heat their homes, the remaining core prices were up 6.3 per cent. It’s the need to eat that is causing the biggest problem. Some of the percentage increases facing shoppers: eggs +39.8; flour+23.3; milk +17; bread +16.2; chicken +16.6; butter 24.6; soups +18.5; Olives +18, especially bad news with big hikes in gin prices in the pipeline that might shake and stir consumers.

Consumers are shying away from increasingly expensive non-essentials: the volume of sales of frozen dinners has fallen by 11 per cent and cookies by 9 per cent. Even upper-income consumers are adapting: Chipotle, McDonald’s and other fast-food chains, and Walmart are reporting inflows of posher consumers trading down.

Biden Throws A Party To Celebrate His Successes

The unexpectedly bad inflation news was accompanied by another data release showing that inflation-adjusted income for the typical household fell last year while income inequality increased for the first time in a decade.  Never one to be troubled by economic reality and facts, on the day of this data dump the President hosted a party on the White House lawn featuring music by James Taylor. Thousands of Biden’s supporters celebrated the passage of his legacy-making Inflation Reduction Act at about the same time as Mark Zandi, the Biden team’s favorite economist, was reporting that the average household is paying $460 per month more for the same stuff it bought a year ago.

Things Get Scary

Even before the new inflation data were released, a new study by a team of three economists was published by The Brookings Institution, a liberal Washington think tank. Jason Furman, chairman of the Council of Economic Advisers under President Obama, waded through the technical definitions, inserted some optimistic assumptions and the usual caveats, and produced an op ed the editors of The Wall Street Journal headlined “Inflation and the Scariest Economics Paper of 2022”. Furman believes that to bring prices down to the Federal Reserve Board’s target of 2 per cent we might need to tolerate an average unemployment rate of 6.5 per cent in 2023 and 2024. He  goes on to estimate that if the Fed were willing to raise its inflation target to 3 per cent, the unemployment rate we would need to live with would be 4 rather than 6.5 per cent, which he characterizes as “healthier for the economy.”

Which brings us back to the war between the Fed and the President. The Bank has increased to $95 billion the rate at which it will reduce purchases of maturing treasuries and mortgages, and when its monetary policy team meets tomorrow it will undoubtedly raise interest rates by 0.75 per cent. But it faces a tough foe. The President’s decision to forgive the debt of mostly non-poor students who will eventually out-earn the taxpayers subsidizing them will pump about $1 trillion into the economy, the infrastructure law another $1.2 trillion, the CHIPS and Science Act more than $280 billion, and whatever part of the $745 billion Inflation Reduction Act that proves not covered by its tax increases.

Despite the trillions in inflation fuel, the Fed is having some successes. Its decision to reduce its support for the mortgage market has already driven interest rates on the typical 30-year fixed-rate mortgage above 6 per cent for the first time since 2008. That, added to increases in house prices has brought a red-hot housing market close to a deep freeze: sales of new homes are down about 30 per cent compared with last year. Bad news for the construction trade.

The Labor Market MIGHT Be Easing Up

The mere talk of the recession the Fed might be pushing the economy into, combined with lay-offs by such as Goldman Sachs, Microsoft, Peloton,, Ford and Siemens, is changing the tone of the labor market. Professional recruiters for the tech industry report doing “a 180”, switching from trying to line up recruits to trying to find job openings for its list of applicants. It is too soon to guess whether that experience will spread to other sectors.

The overall market still has two openings for every job seeker, the participation rate of men in prime working age continues to decline, legal immigration has fallen by over three million workers compared to what it would have been had pre-covid trajectories continued, and the benefits of not working remain significant. All reasons why airlines, hotels and restaurants continue to complain about shortages of workers.

It is too soon to tell whether Biden’s trillions will be sufficient to offset the effects of the Fed’s anti-inflation weapons. Pangloss would argue that the Fed will cool inflation while the President shores up the economy. Economists would call that a soft landing.