MNI INTERVIEW: Fed Can Tame Inflation Without Slump-Andolfatto

Falling inflationary pressures as supply shocks ease and fiscal stimulus is reduced should allow the Federal Reserve to conclude its tightening cycle before it prompts a recession and any big spike in unemployment, former St. Louis Fed economist David Andolfatto told MNI.

“You take a look at the most recent inflation prints, on a monthly basis they’ve come down quite a bit. Year-over-year it looks like you’re getting a nice hump-shaped pattern,” he said in an interview following the Fed’s decision to raise interest rates by another half percentage point last week.

“The Fed can bring inflation down more rapidly than it otherwise would fall, but the reason it’s falling is that fiscal policy has gotten its act together. Why do we need the Fed to spur a recession to bring inflation down more rapidly at the expense of unemployment? Just let inflation come down gradually without the social cost of putting a bunch of people out of work.”

Andolfatto said there is still a risk that the Fed take its monetary tightening campaign too far due to officials’ fear that inflation will prove more persistent than they expect.

“I’m little bit worried,” said Andolfatto, who left the St. Louis Fed six months ago after 13-1/2 years, and is now at the University of Miami.

“They want to see evidence that inflation is coming down persistently, they don’t trust the month-over-month figures, for one month, two months, three months, they might need four months, five months. They don’t want to be headfaked. That desire not to fall for the headfake” creates the danger of overtightening, Andolfatto said.

SO FAR SO GOOD

However, that is not his base case because he thinks policymakers, aware of their dual mandate of price stability and full employment, will remain cognizant of the danger of doing too much.

“As things are unfolding right now, the recent CPI, I’m looking at it with some satisfaction. Inflation is coming down, the unemployment rate is still low, it might tick up a little bit but the numbers still look okay,” he said. Andolfatto was one of the first Fed staffers to warn of the risk of post-pandemic inflation, and he also said in June that inflation had likely peaked when few others were willing to make that call.

These days, his prediction is looking rather prescient: the headline consumer price index has been falling steadily since June, when it hit a cycle peak of 9.1%, coming down to 7.7% in November. The Fed raised rates seven times this year to a range of 4.25%-4.5%.

LABOR MARKET NOT OVERLY STRONG

Andolfatto pushed back against the notion, proposed by many prominent economists and market participants, that a major spike in unemployment and a deep recession are needed to bring down inflation.

“There are forces in place that will move inflation back to target,” he said.

At the same time, he disagrees with the Fed’s argument that the labor market is somehow too strong, including Chair Powell’s assertion that wage growth is too robust to be consistent with price stability.

“Powell keeps on talking about the very strong labor market and demand for workers. How is it possible that the labor market is so strong when real wages are still going down? That position is very untenable,” he said.

“He says we see very rapid wage gains that are not consistent with 2% inflation and lower productivity. But if labor productivity is so low, why are firms screaming for workers?”