Personal Income And Outlays Report Reminds Us How Little Control Powell Really Has Over Inflation
The Fed Can Raise Rates. It Can't Bring Down Supply-Side Inflation
As I noted yesterday morning when the August Personal Income and Outlays Report was released, it shows Fed Chairman Jay Powell losing his fight against inflation.
When we peel the layers of the onion back a little farther, however, we can begin to see just how badly Powell has miscalculated on inflation, and how little control he has over inflation going forward.
Despite having nearly six months of rate increases in the history books, the Federal Reserve has yet to show any meaningful progress on consumer price inflation. The rate increases are doing an excellent job of unwinding multiple years of asset price inflation within equity markets, but as that is not the inflation about which the Fed claims to be worrying, Powell’s success in that area is cause for concern on Wall Street, not cause for celebration.
First, The Good News: PCE Index Fell, Real Disposable Income Still Rose.
At first glance, the August PCE report did have some bright spots: consumer price inflation year-on-year per the PCE Index fell for the second month in a row, echoing the trend established earlier by the Consumer Price Index headline number. Real disposable income also eked out a small gain month on month.
Personal income increased $71.6 billion (0.3 percent) in August, according to estimates released today by the Bureau of Economic Analysis (tables 3 and 5). Disposable personal income (DPI) increased $67.6 billion (0.4 percent) and personal consumption expenditures (PCE) increased $67.5 billion (0.4 percent).
The PCE price index increased 0.3 percent. Excluding food and energy, the PCE price index increased 0.6 percent (table 9). Real DPI increased 0.1 percent in August and Real PCE increased 0.1 percent; goods decreased 0.2 percent and services increased 0.2 percent (tables 5 and 7).
However, that is where the good news ends for August.
Consumer Price Inflation And “Core” Consumer Price Inflation Rose For August
While the year-on-year PCE figures shows a top-level decrease in consumer price inflation, month-on-month, the numbers were not nearly as kind.
While energy and food price inflation trended down again for August, consumer price inflation went from being negative 0.12% in July (prices fell) to a positive 0.29% in August.
More distressingly, the “core” PCE Index (PCE less food and energy) surged from 0.04% in July to 0.56% in August.
Additionally, year-on-year food price inflation surged to 12.36% in August, as did “core” consumer price inflation, going from 4.67% to 4.91%.
While prevailing wisdom on Wall Street is that changes by the Fed in monetary policy—i.e, interest rate rises and falls—takes as long as 9 months to two years for the full impact to be felt, with the Fed’s tighter monetary policy now entering its sixth month, for both core inflation and food price inflation to still be getting worse calls into question the actual influence interest rate hikes have over inflation, and the extent to which other, external, drivers of upward price pressure are driving inflation despite the interest rate hikes.
Disposable Income Declines Cut Against Labor Markets Pushing Up Costs
While real disposable incomes did eke out a slight gain month on month, the reality of the August Personal Income and Outlays report is that disposable income is still significantly down from a year ago.
With real disposable incomes declining—meaning that inflation is eroding the purchasing power of wages even with current-dollar increases—the premise that tight labor markets are driving inflation is mathematically impossible. A “tight” labor market would involve rising wages and rising disposable incomes, and that is simply not what the data shows.
When wages rise less than the pace of inflation, that indicates the presence of other, and potentially more influential, inflation drivers than just labor costs. When changes in disposable income do not correlate to changes in inflation—and the data clearly shows they do not—we cannot consider labor conditions to be a primary driver of inflation.
At the present time, there can be little doubt that labor market conditions are not a primary driver of inflation, but are instead being shaped by that inflation. The data admits of no other interpretation.
Interest Rates Are Aiming At The Wrong Inflation Targets
If the Friedmanite truism that inflation is strictly a monetary issue were demonstrably applicable for the present inflation, monetary policy—which is to say, interest rate manipulations—would be the reasonable response.
However, the data does not support the Friedmanite truism. This time, things really are different. Different responses and different strategies should be the order of the day.
When the August Consumer Price Index Summary report was released, I argued then that the data illustrated how little actual control Jay Powell could exert over inflation.
The August PCE data does nothing to alter that conclusion. The PCE Index might be lower than the CPI, but the trends and the internals demonstrating price distortions within the US economy are the same.
It is no defense of the past decades worth of expansionary monetary policy to argue that the premise that merely hiking interest rates in the present environment will suffice to contain consumer price inflation and return it to its former levels. The data of the past several years more than suffices to show a more complex and more nuanced background for the consumer price inflation we are seeing today. It naturally follows that the Federal Reserve—as well as the entirety of the federal government—needs to have an inflation response that speaks to that complexity and that nuance.
Focusing on interest rates to the exclusion of all else means ignoring other, more influential, inflation drivers. In the present circumstance, interest rates are simply aimed at the wrong inflation targets to have the desired effect. That makes them the wrong weapon, or at least an insufficient weapon, to deploy in a fight against inflation.
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