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Core Dangers for the Fed and China

Just as a fixation on core inflation can mislead central banks, as it has done with the US Federal Reserve, the power of a “core leader” like China’s Xi Jinping is a recipe for misdirected and ultimately unsustainable policy regimes. The very notion of a core adds a false sense of precision when addressing complex problems.

NEW HAVEN – It is tempting to give America’s Federal Reserve great credit for its recent about-face in tackling inflation. It is equally tempting to give Chinese President Xi Jinping great credit for his stewardship of a rising and strong China. But neither deserves it – and for a similar reason.

That is certainly true of today’s Fed. Yes, the US central bank has now hiked the federal funds rate (FFR) by 75 basis points three times in a row – the sharpest increase in the benchmark policy rate over a four-month period since early 1982. Predictably, many politicians and pundits are howling in protest, warning of the risks of overkill. I disagree. It was past time for the Fed to start digging itself out of the deepest hole it has ever been in.

My emphasis is on the word “start.” The nominal FFR, now effectively at 3.1%, remains five percentage points below the three-month average of the headline CPI inflation rate of 8%. Notwithstanding the Fed’s newfound determination to arrest a serious outbreak of inflation, it is all but impossible to accomplish that objective with a sharply negative real FFR of around -5%.