[Unfounded Fed tightening myths are backfiring on the economy.]
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ALREADY IN A HOLE, THE FEDERAL RESERVE KEEPS DIGGING  
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Jeffrey Sonnenfeld, Steven Tian
November 8, 2022
The American Prospect
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_ Unfounded Fed tightening myths are backfiring on the economy. _

Federal Reserve Chairman Jerome Powell speaks at a news conference
following a Federal Open Market Committee meeting, November 2, 2022,
in Washington., Patrick Semansky /AP Photo

 

The election-season frustration of Biden officials over ill-timed
economic assaults on housing and interest rates by the Fed is
justified. While they do not want to politicize the Fed, someone needs
to puncture the mythology driving the desperate, ill-conceived moves
to address unrelated spikes in a few finished goods like food and
fuel.

The comedian Will Rogers famously declared, “If you are trying to
get out of a hole, stop digging.” Last week’s strong jobs report,
with businesses boosting hiring in October by a more-than-expected
261,000 and accelerating average hourly earnings, suggests that the
Federal Reserve needs to face the facts—unless the Fed induces a
catastrophic recession, its policy levers will have limited if any
impact on the presumed inflation indices it is targeting. Indeed, the
Fed’s preferred inflation statistics have only accelerated upward
since the start of rate hikes six months ago.

The Fed’s tool of choice—tightening monetary conditions—is a
blunt, imprecise wrecking ball that serves to drain liquidity from the
economy. But draining the water from the pool does not make someone a
better swimmer. Chairman Powell continues to target the wrong
underlying drivers of inflation: Despite his bellicose attacks on
“overheated” employment levels
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the source of inflation, heightened by his frustration with last
week’s continuing high job creation
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sectors, there is no correspondence, correlational or causal, with
such data.

As we’ve noted before
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real average hourly earnings are actually down by 3 percent
year-over-year
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and there has been no data, science, or track record to support the
mythic Phillips Curve superstition—which suggests a relationship
between unemployment and inflation—for at least 40 years. Jay
Powell himself acknowledged this just a few years ago
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along with macro experts, the NBER, and others. The data clearly shows
the anachronism of “wage-push” inflation died in the 1970s with
the diminished voice of trade unions, global labor outsourcing, and
technological substitution

American workers holding jobs are not the cause of inflation, but
perhaps the genuinely egregious wage inflation is in the remarkably
low unemployment levels among those comfortable commentators in the
chattering class calling for 10 percent unemployment. Indeed, the
pace of gains for median economist salaries far outstrips inflation by
20 percent over the last decade
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egregiously, as reported by _Forbes_, the average S&P 500 CEO made
324 times
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than their median workers in 2021, with CEO pay doubling over the last
five years—50 times faster than the pace of inflation and 20 times
the pace of shareholder returns. In fact, CEO pay rose 1,322.2 percent
from 1978 to 2020 adjusted for inflation, compared to 18 percent for
average workers. It is easy for these princely compensated economists
and executives to divert attention from their own outsized salaries by
blaming hapless American workers and pushing the Fed toward inducing
job loss.

If anything, the most obvious accomplishment of Fed tightening so far
seems to be stripping middle-class American families of their most
important assets. The Fed has single-handedly crippled the housing
market with prohibitively high 7 percent mortgage rates, despite
strong underlying latent demand
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Worse, this has crashed home-building despite the housing shortage in
many large metropolitan areas. Not only is Fed tightening destroying
housing affordability now, it is destroying it for the future.

Add to that stock market indices crashing ~30 percent since Fed
tightening began, and the wealth effect has been pummeled, which will
almost certainly have an impact on consumer spending and economic
growth before long.

M2, a measure of the money supply, is already decelerating at the
fastest pace since World War II with many commodities down 70 percent
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yet inflation readings remain stubbornly high. That’s for the simple
reason that many of the primary drivers of inflation are simply
outside the Fed’s control. The lingering high costs in food and fuel
are largely a product of (1) Russian efforts to undermine grain
markets despite truly historic global bumper crops
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the world this harvest, and (2) Saudi collusion with Russia in oil
markets
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artificially restrain oil supply even though the Saudis were already
enjoying a 75 percent profit margin
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Neither of these geopolitically driven pricing matters are reachable
by Fed policies. On fuel, it is also not the Fed’s fault that
refineries are using the invasion of Ukraine as a pretext to
price-gouge, sending refinery margins up 400 percent, adding an excess
40 percent to the price paid by consumers at the pump.

Likewise, as we know all too well from our work chronicling
the unprecedented retreat of 1,000-plus global businesses from Russia
practically overnight
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inflationary pressures from reshoring supply chains from “just in
time” to “just in case”
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redundancy and flexibility is a necessary by-product of rising
geopolitical tensions, but completely outside the Fed’s reach. Nor
can the Fed do much about historically low labor force participation
rates or stalled immigration bottlenecks
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labor supply
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To each of these inflationary challenges, there are policy solutions.
As one example, oil supply can be increased by bringing Saudi Arabia
back to the table through a rebalancing of relations, including
through cutting off one-sided disadvantageous transfers of sensitive
defense technology and know-how if necessary, as we have proposed
with Sen. Richard Blumenthal
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Congressman Ro Khanna.

But this is outside the scope of the Federal Reserve. Short of
inducing a catastrophic global recession, its narrow tools cannot
reach these geopolitically driven pricing matters. The Fed’s
fruitless, quixotic assault on American workers needs to give way to a
focus on genuine, alternative approaches to tackle the drivers of
persistent inflation.

Just two years ago, we celebrated employed frontline employees as
heroic “essential workers.” But now the Fed wrongly vilifies such
productive, gainfully employed Americans as the source of our
inflation. Instead of blaming innocent workers, let’s focus on the
actual global causes of food and fuel spikes while all other domestic
prices are dropping dramatically. The philosopher Abraham Kaplan
referred to the Fed’s pathology as the paradox of the law of
instrument, so that for a child with a hammer, everything looks like a
nail. Sometimes a saw or a screwdriver makes more sense—but the Fed
only has hammers.

_JEFFREY SONNENFELD is a senior associate dean and Lester Crown
Professor of Leadership Studies at the Yale School of Management after
18 years at Harvard University._

_STEVEN TIAN is director of research for the Yale Chief Executive
Leadership Institute, a Yale alumnus, and formerly an analyst at
Rockefeller Capital Management._

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* inflation
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* federal reserve
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* profits
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* Supply Chains
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* Ukraine
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* Russia
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* Saudi Arabia
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* Oil
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* food
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* recession
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