The Fed fights COVID Largesse

While hope springs eternal that bank run troubles and tightening bank credit will make Jerome Powell and company come to their senses and stop the rate hike madness, there is a not so tiny problem the Fed knows and the average Joe and Jane doesn’t.  Former Dallas Fed President Robert Kaplan was interviewed by Praxis Financial Publishing and said the inflation fight is being undercut by expansive fiscal policy. 

While we’ve all moved on from COVID, the government’s COVID largesse has a long tail. Kaplan’s been talking to mayors from around the country and they tell him “American Rescue Act (ARPA) money must be spent by states and municipalities between now and the end of 2024 or it’s lost. If you live in Las Vegas and wonder why seemingly every street in town is a cone labyrinth with construction to break out any minute, that’s the reason, use it or lose it. Government never likes to lose it when spending it helps one or more of its constituents.  

So the Fed is trying to cool demand for goods, services, and labor at the very same time local spending is increasing the demand for goods, services, and labor.  Kaplan added, “Also, certain portions of the infrastructure bill and Inflation Reduction Act funds are earmarked for projects that are increasing demand for labor.”

With all of this fiscal spending, as well as higher interest rates, the Congressional Budget Office expects the federal government to run a deficit of almost $2 trillion dollars in fiscal 2024, nearly 10 percent of GDP. As every Keynesian knows, running a deficit of this size now is stimulative to the economy, again, at a time when the Fed is trying to cool the economy.

No wonder the Federal Reserve Bank of St. Louis President James Bullard said he is backing two more rate increases. Even the dovish Neel Kashkari said if the Fed does pause, it should signal tightening isn’t over, reports Bloomberg. 

After the personal consumption expenditures price index, the Fed’s preferred inflation gauge, rose a faster-than-expected 0.4% in April,  Cleveland Fed President Loretta Mester told CNBC, “When I look at the data and I look at what’s happening with inflation numbers, I do think we’re going to have to tighten a bit more.” 

She said, “Everything is on the table in June.”

Everything but market price discovery.