It turns out that inflation was nottransient.” Federal Reserve officials were confident in 2021 that consumer price increases would not last and that they needed to keep interest rates near zero to help the economy navigate COVID-19. But Neel Kashkari, chairman of the Minneapolis Federal Reserve, now admits that was a mistake.
Many of us—those in the Federal Reserve and the vast majority of outside forecasters—made the same mistakes, first, being surprised when inflation rose so much and, second, assuming inflation would fall quickly. Why did we miss it? he wrote on a Wednesday article for Average.
Kashkari blames the models that central bankers use to forecast inflation, arguing that they do not properly account for so-called “price inflation”. He used the analogy of Uber driver’s experience on a rainy day to describe this type of inflation. ride-sharing companies like Uber and Lyft offer their drivers what are called peak prices when demand for rides increases. Price increases can significantly increase the cost of a ride, reducing demand and encouraging more drivers to work and increasing supply.
Kashkari argued that during the pandemic, the economy has been hit with some form of corporate price spikes due to a surge in demand as COVID lockdowns set in, coupled with shortages created by broken supply chains.
But unlike the surge in prices for ride-sharing companies, salaried workers have not grown at the same rate. This dynamic has driven down inflation and corporate profits. ascendwhile real wages fell.
Kashkari said the key to the Fed’s “misfire” was that inflation over the past year was driven by that price spike that the Fed’s models failed to account for, rather than by a tight labor market or changes in consumer inflation expectations – the two most common sources of rising prices during previous periods of high inflation.
“In these workhorse models, it is very difficult to generate high inflation,” he explained. “Either we have to assume a very tight labor market…or we have to assume an unanchoring of inflation expectations. That’s it. From what I can tell, our models seem ill-equipped to handle a fundamentally different source of inflation, specifically, in this case, a price spike.
Kashkari went on to say that he believes the Fed should continue raising interest rates “at least in future meetings” due to its inability to accurately forecast inflation. A rate cut should not even be considered, he added, until officials are “convinced” and inflation is “on track to come back down” to its 2% target rate. .
“Given the experience of the 1970s, the mistake the FOMC must avoid is to cut rates prematurely and then re-ignite inflation,” he said, referring to the Open Market Committee of the Fed, which determines interest rate levels. “That would be a costly mistake.”
Kashkari added that his article was not meant to criticize other Fed officials, noting that he too was wrong about inflation last year.
“It is meant to be an honest assessment of what we missed and why we missed it in order to shed light on what we should learn in the future,” he wrote.
This story was originally featured on Fortune.com
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