Would the Fed Be Justified in Raising Interest Rates?

Leave aside for the moment whether the Federal Reserve should be the master planner of monetary policy, because that is a completely different issue; in that role, the Board of Governors has its hands on the knob that sets monetary policy. Should they turn it?

Ed wrote about the basic facts after the results were released, and the bottom line is that inflation ticked up to 3.7 percent annually. Ed noted one of the most relevant points: the market seems to have overreacted to potential interest rate hikes. Or should I say, the market worries that the Fed will overreact.

As the data shows, this is almost entirely related to fuel prices, and perhaps mainly related to diesel. Almost every other general category shows mild inflation of the kind associated with strong economic growth. Even inflation in electrical (4.4% annual) and natural gas (5.0%) utilities shows moderate inflation at worst. Fuel and fuel oil prices have increased by 20.4% overall this year, and in just this month, have shot up by 9.3% overall in September alone, with fuel oil up 15.3% last month after a 10.1% increase in August. 

Those numbers are BRUTAL, and I feel them as much as you do. On a consumer level, anyone who complains about energy price increases has every right to. You're not whining if you are complaining; the pain is very real. 

But on a macro level, when it comes to interest rate hikes, does an inflation bump driven by a supply shock and risk premiums in a commodity justify a hike?

The short answer is "No," because the hike isn't driven by a general "overheating" of the economy, and even in the obvious AI/datacenter bubble, private markets are starting to correct on their own. Not fast enough for my taste, but raising interest rates isn't the best solution to a bubble in a specific sector of the economy suffering what Alan Greenspan called "irrational exuberance." 

The one counterpoint I can think of, which suggests the COVID-era money flood hasn't been wrung out of the economy yet, is that core inflation is still above the Fed's 2 percent target and has stubbornly sat at about 2.7 percent. That is a real problem, although frankly I find the whole "targeted inflation" idea rather appalling on its own. Telling people you intend to devalue the currency forever strikes me as offensive on its face, but, oddly enough, the Fed doesn't listen to me. 

But few people expected the Fed to hike rates because of that number; the spike in the annualized inflation rate sparked the speculation. And on its face, that makes little sense to me. 

Yes, the transportation sector is feeling the crunch now, but that shouldn't be a permanent change from dollar devaluation; it's a supply crunch that should ease at some point. Not soon enough to save the midterms, but economically speaking, it is unlikely to be permanent. 

Predictions are hard, especially about the future, so I won't speculate about what the Fed will do. But by its own logic, this inflation rate shouldn't be a reason to hike rates.