Last month, Federal Reserve Bank Chair Jerome Powell announced that interest rates will remain unchanged. For the time being.
The Fed is looking out for our best interests… which in this case means, a high interest… rate.
High interests rates are one of the few things in life we can count on. Along with death, and taxes.
Mr. Powell believes that, by keeping interest rates high, the Federal Reserve can influence inflation. Certain other people also believe this. I might even believe it myself, after a couple of beers.
What Mr. Powell doesn’t often explain is that there are two kinds of inflation. Bad inflation, and good inflation.
An example of bad inflation: I want to buy a used Subaru, and I discover that the price has increased by 10% since last year, due mainly to a shortage of computer chips for new cars, thus increasing demand for used cars.
An example of good inflation: I want to sell a used Subaru, and I discover that the price has increased by 10% since last year, due mainly to a shortage of computer chips for new cars, thus increasing demand for used cars.
Another example of bad inflation: the price of a Big Mac has increased by 50 cents since the last time I ordered one.
Another example of good inflation: I’m the McDonald’s employee serving the Big Mac, and I’m now making 50 cents more per hour.
When the Fed decides to keep interest rates high, it’s a wonderful thing because it helps keep the price of onions from steadily increasing. But it also makes it impossible for anyone to afford a house, due to mortgage rates. So, kind of a trade-off?
The problem with these conflicting situations is, we’re letting Mr. Powell and his friends decide for us whether we want a bag of onions, or a place to live.
There are many examples of how inflation affects us. Mostly, I’m concerned about how inflation affects me, personally, although I understand Mr. Powell doesn’t know me from Adam. And probably doesn’t want to know me.
Another person who doesn’t know me: Noam Hassenfeld.
Noam Hassenfeld is the host and senior producer of ‘Unexplainable’… Vox.com’s science podcast about everything we don’t know. (“We” refers to ordinary people like you and me — not to people like Mr. Powell who think they know everything.)
In a recent episode of ‘Unexplainable’, Mr. Hassenfeld looked at why inflation behaves in an unpredictable fashion. He identifies two basic theories for why inflation has slowed down over the last couple of years.
Theory 1: It was the Fed
In mid-2022, the Federal Reserve raised interest rates, and soon after that, inflation started falling. Case closed, the rate hike is what did it. Right?
The issue is that the normal way interest rates influence inflation is by raising unemployment. Interest rates go up, businesses struggle to hire more workers, and unemployment goes up. But in 2022, unemployment barely changed. Something else was going on.
Mr. Powell and his buddies try to increase unemployment because unemployed people have less money to spend, so they stop buying stuff, thus lessening demand, and that brings prices back down. (Actually, it keeps prices from going up quite as fast. No one can make prices come down.). This works fine for people who still have jobs (like Mr. Powell) but it really sucks for the people who are now unemployed.
But in 2022, unemployment barely changed. So much for Theory 1.
Mr. Hassenfeld has identified another theory, which might be called, “Raise My Wages? No thanks.”
Economists, like for example Adam Posen of the Peterson Institute for International Economics, argue that inflation came down because of people’s expectations.
As Posen explains, “If people are sure that the central bank or society somehow will get inflation down in the future, they don’t tend to react very much to movements in inflation today.”
People don’t feel the need to ask for raises, and businesses stop raising prices. Essentially, it’s a self-fulfilling prophecy.
This is the craziest theory yet. Everyone always feels the need to ask for a raise, no matter what, because we are constantly getting underpaid. And businesses always try to raise their prices, because that’s what businesses do best.
The real reason inflation started to decline in 2022 is COVID. While we were locked down, we had nothing to do except shop on Amazon. By 2023, our storage units were overflowing with the crap we bought, and we had no place to put any more stuff. (Also, we had maxxed out our credit cards.)
When people stop buying stuff, prices come down.
So there we have the solution to inflation. Stop buying stuff, America.
The ‘Unexplainable” … explained.