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Central Banks Are Still Far Behind the Inflation Curve

Inflation at current levels is a severe economic, social, and political problem – a scourge that disproportionately affects the poor and the financially unsophisticated. So, why are the Federal Reserve, the European Central Bank, and the Bank of England actively fueling it?

NEW YORK – Major central banks have lost the plot when it comes to fulfilling their price-stability mandates. In April, 12-month US consumer price index (CPI) inflation was at 8.3%, down slightly from 8.5% in March, and the US Federal Reserve’s preferred inflation gauge, the core personal consumption expenditures price index (which excludes food and energy), was at 4.9%, down from 5.2% in March. But what the Fed should be doing is the opposite of what it actually is doing.

After increasing the target zone for the federal funds rate by 50 basis points to 0.75-1%, at its May meeting, the Federal Open Market Committee indicated that it will stick with 50-bps hikes at its June and July meetings. According to the May meeting minutes, all participants agreed that the US economy was very strong, the labor market was extremely tight, and inflation was well above target. Yet they decided that the FOMC “should expeditiously move the stance of monetary policy toward a neutral posture” (emphasis ours).

There are two problems with this. First, the Fed’s monetary-policy stance should be restrictive, not neutral. Instead, the FOMC merely noted “that a restrictive stance of policy may well become appropriate depending on the evolving economic outlook and the risks to the outlook.” Second, there is nothing expeditious about two additional 50-bps increases. The policy rate’s upper bound will still be only 2%, below the consensus estimate of a 2.5% neutral rate (the sum of a neutral real rate of 0.5% and the 2% inflation target).

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