Congress Is Working Against the Federal Reserve

The Fed is tightening. The Senate is spending. And the incoming GOP House is neutered.

Sen. Richard Shelby (R-Ala.) speaks to reporters in Washington, on Feb. 12, 2019. (Mark Wilson/Getty Images)

Since last Wednesday—when the Federal Reserve rate decision dropped at 2:00 p.m. EST—to the market close on Friday, the Dow Jones Industrial Average slipped 4.2 percent and the S&P 500 Index fell 4.9 percent. While most business columnists put those declines mostly on the Fed’s rate increase, a deeper dive speaks to a more negative outlook for the economy.

Last week’s release of the Federal Open Market Committee’s (FOMC)  “Summary of Economic Projections”—commonly referenced as the “dot-plots,” contemporaneously with the rate decision—projected a poor picture of America’s economic future, and the markets responded accordingly.

The central tendency of the FOMC’s rate projections is for growth at 2 percent or lower through 2025 and beyond. For 2023, the central tendency is just 1 percent at the top of the ranges, 0.4 percent at the lower end.

(FOMC projections from the Federal Reserve)

The FOMC also expects a generally higher unemployment rate as the economy slows. While the central tendency tops out at 4.8 percent, the range of estimates goes up as high as 5.3 percent.

Also higher are estimates of inflation, with the central tendency ranging as high as high as 5.8 percent this year and arguably sanguine estimates that it will decline to 2 percent by 2025.

Finally, the federal funds rate is targeted to go as high as 5.4 percent under the central tendency in 2024, but with a range as high as 5.6 percent.  (That would easily equate to a mortgage rates as high as 8–9 percent!)

It is highly unlikely that the Fed will be able to return the economy to a 2 percent target rate of inflation without incurring recession. As I had written some weeks ago, a few Washington progressives have expressed a desire to avoid recession and higher unemployment and are willing to accept inflation at 3.5 percent. Fed Chair Jerome Powell seemed to shut down that notion during the press conference on Dec. 14, but he did leave the open the door just a sliver to the target rate. When Grady Trimble of Fox Business asked whether there will be “ever a point where you actually reevaluate that target and maybe increase your inflation target if inflation was ’sticky,'” Powell replied,

“That’s just ... changing our inflation goal is just something we’re not ... we’re not thinking about, and it’s something we’re not going to think about. It’s ... we have a 2 percent inflation goal, and we'll use our tools to get inflation back to 2 percent. I think this isn’t the time to be thinking about that. I mean, there may be a longer run project at some point [emphasis added]. But that is not where we are at all. The Committee, we’re not considering that. We’re not going to consider that under any circumstances. We’re going to ... we’re going to keep our inflation target at 2 percent. We’re going to use our tools to get inflation back to 2 percent.”

Let’s hope so.

Continuing Inflation, Increasing Rates

Most of the inflation we’re seeing now is services inflation. Goods inflation is falling with supply chains being largely restored. And while there have been a lot of high-profile layoffs, many of those are by tech firms and among holders of non-immigrant H-1B visas. Those workers’ layoffs do not enter into the unemployment rate because they are no longer considered part of the workforce after 60 days of being laid off. So, with a relatively strong labor market, and a social safety net that has become, for some, a hammock (the 1996 work requirements to receive income support were eviscerated under President Barack Obama), we can anticipate continuing higher wages to get workers, higher services inflation, and low unemployment.

We’re also seeing a feckless lame-duck Congress. Word this weekend is that Sen. Richard Shelby (R-Alabama), the chief Republican appropriator, is working with Senate Minority Leader Mitch McConnell (R-Ky.) and Senate Majority Leader Chuck Schumer (D-N.Y.) to pass a $1.7 trillion omnibus spending bill that will take the government through next September, more than $200 billion over last year. That will effectively neuter the incoming Republican-led House of Representatives in its efforts to reduce the budget and that many new Republican House members had campaigned on.

Summary

Fiscal policy and monetary policy are working at cross-purposes. As the Fed tightens—and will likely continue to do so—Congress and President Joe Biden are set upon spending more.

As I’ve said in some of my earliest columns for The Epoch Times, the Fed needs to reduce its balance sheet to reduce inflation. That has just barely started to happen and to take effect. Until we see more reductions, and at a more aggressive pace, as well as a reduction in federal spending and tougher work requirements for public benefits, U.S. inflation will linger.

The result will be stagflation.