James MacIntosh, writing for The Wall Street Journal, is worried about the Fed worrying too much about its last mistake regarding inflation, when it was too slow to respond to rising prices. For instance,
But there’s a fundamental difference between the new oil shock and the postpandemic boom. Inflation today, already visible in rising prices at the pumps, is driven by restricted supply as Iran cuts off oil and other shipping through the Strait of Hormuz. The 2021-22 inflation was driven by soaring demand as stimulus-rich consumers emerged from enforced hibernation during Covid lockdowns.
Central banks know how to deal with too much demand. They should have raised rates much earlier than their eventual 2022 rises to hold back borrowing and spending. Today, they can’t do anything about the hit to supply, because, as the saying goes, you can’t print oil.
The problem with this, though, is in the relationship between inflation—rising prices—and rising—”too much”—demand. Rising prices occurs because demand is rising faster than supply can rise to satisfy it; it does not occur simply from rising demand. If we want more stuff—here oil—and the production of oil exists to satisfy that rising demand, prices don’t rise; there is no inflation.
Inflation is always and only in the relationship between demand and supply; it is never in demand alone or in supply alone. The only way there can be too much demand if there’s too little supply (the other side of this is true, too: the only way there can be too little demand is if there’s too much supply, which results in falling prices—deflation). More demand than supply can satisfy and less supply than can satisfy demand are the same thing.
So, what can/should the Fed do about today’s too little supply of oil relative to the demand for it and the consequent rise in prices? Its mandate, aside from full employment, is price stability: no change in price level, or via its goal, keeping price increases to 2% inflation. The Fed’s tool for this interest rates, which is to say here, reducing demand by raising the cost of the money that is that demand. Thus: raise interest rates when that inflation gets out of hand/rises too far above that 2% in a sustained upward trend. This is wholly independent of both supply and demand individually and responsive only to the relationship between the two.
The problem here is that “out of hand,” “too far above,” and “sustained” are each individually only hazily defined criteria. My own opinion is that with employment, which is a consequence of stable prices as well as its own economic condition, close to full and stable and currently rising prices not yet out of hand or too far above 2% or on a sustained upward trend, the Fed should do nothing more than keep a watchful eye. Trying to time the market with enough precision to preempt inflation without cutting off growth is as much a fool’s errand as an individual investor’s timing with a view to precise top or bottom picking.
This also is consistent with my view that current interest rates are consistent with (if a bit lower than) interest rates that historically are associated with 2%± inflation, so there’s nothing generally that the Fed needs to do.
