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The Federal Reserve’s battle against inflation is in full swing. The Fed has already raised interest rates four times in as many months as the inflation rate has soared to 9.1%. While the U.S. has not officially entered a recession, the national economy has shrunk for two consecutive quarters. Straight Arrow News contributor Larry Lindsey says the Fed’s aggressive actions may ultimately work to corral inflation but could spark a deep and painful recession.
Times are tough. Right now, the Federal Open Market Committee that sets interest rates and determines how much money is in circulation, has two bad things going on The first is it has an inflation rate by its preferred measure of 6.8%. It wants two. Second, we’re probably in a recession. Growth in the first half of this year averaged less than -1.6%. Again, their target is two.
So they’re missing their target on both counts. So what on earth are they going to do? Well, right now they’ve decided to target the inflation rate first and foremost. And they’re going to be raising rates very sharply. What has the Fed done in the past? Well, a few decades ago, a man named John Taylor, professor at Stanford, came up with something he called the Taylor rule, which isn’t really a rule, it was just a way of estimating with regression equations, what the Fed was doing. And he came down with two basic rules.
First, how far is the Fed off in terms of real growth? And second, how far off is the Fed from its target in terms of inflation? And then he said, “If things were normal and they were right on target, we should be running an interest rate two points above inflation.”
Well, if we applied that formula now, the fed funds rate, which they’re just about to raise to a three to three and a quarter percent range, should be 9.4%. They are six points off. According to the Taylor rule and what the Fed’s done in the past, interest rates should be three times what they are now. Well, that gives a pretty simple answer. They should be hiking rates.
Well, so far so good. The problem is that it’s going to cause the recession to probably be deeper than it otherwise would have been.
