CPI Numbers Highlight Fed’s Many Mistakes

The Bureau of Labor Statistics just released the monthly increase in the Consumer Price Index for December. The number indicated that consumer prices increased by .4%. For the prior 12 months, the CPI increased by 2.9%. Worse, the annual increase in the core CPI was 3.2%.

In June 2022, after eighteen months of watching the CPI steadily increase until it peaked at 9.1%, the Fed finally realized that price stability is the primary goal of the Federal Reserve’s Monetary Policy. Fed Chair Powell said that the policy would now be geared to bring inflation down to 2%. Recall it was 1.4% in December 2020.

To accomplish that, Powell sharply increased the Federal Funds Rate numerous times until July 2023 when that rate was raised from near zero to over 5%. Inflation was going down. By then the annual CPI had dropped to 3.2%. Much of that decrease was due to falling energy prices caused by weak worldwide demand for energy.

Excluding energy and food the annual CPI was 4.7% in July 2023.

Then, for whatever reason, the Fed mistakenly stopped raising interest rates. As a result, the CPI, which was supposed to fall to 2% or less, stayed around the 3% level. And it is at that level now, about a year and a half since the Fed stopped raising interest rates.

Last summer it looked like the inflation could finally fall under 3%. But then, for no solid economic reason, the Fed started to cut interest rates. In September, November and then in December the Fed lowered the Federal Funds rate, in total, by a full 1%.

That too was a mistake. The CPI didn’t fall further in 2024.

“When you step back and look at the overall state of inflation, we’re not really going anywhere,” said Sarah House, senior economist at Wells Fargo. “While there has been progress, the pace has been really disappointing.”

When the Fed cuts the Federal Funds Rate, the expectation is that all interest rates will fall. That’s simply because when the Fed looks at the data, they conclude that that market is poised for lower interest rates. Cutting the Fed Funds Rate reinforces what the Fed perceives to be market conditions favoring lower interest rates.

The Fed was wrong.

Since the 1% drop in the Fed Funds Rate, the interest rate on ten-year Treasury Bills has increased nearly a full percentage point. That rate is nearly 5% today.

Mortgage rates which had fallen to 6.3% in August 2024 are now at 7%. It is clear the Fed erred.

The Fed would argue that they paused the interest rate increases in July 2023 because they did not want to significantly increase the unemployment rate. They said they could bring the economy to a soft landing where inflation would fall to the 2% level, and they could keep unemployment near 4%, which is considered a full employment level.

For the last six months, the economy has been operating at a full employment level. The current unemployment rate is 4.1%. Last month the economy added a whopping 256.000 new jobs.

If the Fed is serious about bringing inflation down, it must hold interest rates constant until real progress is seen toward reaching the 2% goal. An argument could be made that the Fed should raise the Fed funds rate when they meet later this month.

With the unemployment rate at a full employment level and with inflation now in the fifth year of being abnormally high, the Fed must be more serious about bringing the inflation rate down to their stated target of 2%.

The longer the Fed takes to bring inflation down, the more difficult the problem becomes. Powell erred when he kept interest rates near zero in 2021 and halfway through 2022. He erred when he stopped raising rates in July 2023. And he erred again when he cut interest rates three times at the end of 2024.

Unfortunately, the country is stuck with Powell until May 2026. Let’s hope President Trump can bring the inflation rate down by vastly increasing the supply of energy which will cause energy prices to plummet. Energy accounts directly for about 8% of the CPI and indirectly for nearly 30% of the CPI.

The country can’t rely on the mistake-prone Jerome Powell to solve this inflation problem.

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