With Oil Prices Sky-Rocketing … Should the Fed Raise Interest Rates?

As the New York Times reported,

With the labor market on firmer footing than just a couple of months ago, more Fed officials have embraced the possibility that rates may need to rise to get inflation fully under control. “I want to be clear about my risk assessment: The risks remain tilted toward ⁠higher inflation,” said Lisa D. Cook, a Fed governor, in remarks on Wednesday. “I am prepared to raise rates, if the expected disinflation does not appear in a timely manner.” That followed a speech last week from Christopher J. Waller, another governor, who made clear that he could “no longer rule out rate hikes further down the road if inflation does not abate soon.” That, he added, was “especially true if measures of inflation expectations, some of which have risen lately, show signs of becoming unanchored.”

The meaning is clear, even if the The New York Times used the passive voice (rates may need to rise—as if rates have a mind of their own): the Fed is going to pursue higher rates.

Meanwhile, Trump insists that he isn’t bothered by the rising cost of living:

President Trump on Friday defended his controversial remarks earlier this week when the president said he was not factoring in Americans’ cost of living concerns during negotiations to end the conflict with Iran. “That’s a perfect statement. I’d make it again,” Trump told Fox News’s Bret Baier, ahead of his return to the U.S. from a summit in China. The president told reporters on Tuesday that the “only thing” that matters in these talks is preventing Iran from obtaining a nuclear weapon. “I don’t think about Americans’ financial situations. I don’t think about anybody. I think about one thing: We cannot let Iran have a nuclear weapon,” he said.

And he proceeds with his way-over-budget spending on pool painting, gold-plating, Arc de Trumph building, ball room developing, and insurrectionist rewarding $1.776 billion slush fund, while his Treasury secretary is face planting the President’s likeness on a $250 dollar bill that most Americans will never be able to afford to own. Fittingly, the main use for high-denomination currency is for drug and gun smuggling, bribing of public officials, and other nefarious pursuits. This new bill will restore the US dollar as the criminal class’s favorite currency—displacing the euro’s highest current note of €200 (the €500 was discontinued in 2012 precisely because it was believed to be financing illegal activity).

Leaving aside the administration’s disconnect from Americans’ affordability crisis, what can possibly stand behind the Fed’s logic that it is a good idea to fight inflation that arises from Trump’s misguided war of choice against Iran, which predictably shut off about a fifth of the world’s oil shipping? Consumers are cutting back on general spending so that they can fill up their gas tanks—enriching US oil producers (who, thankfully, do not need to ship oil through the Hormuz Strait). Big box stores that cater to the working classes are tallying lower sales. Outside of the new plutonomy class, belts are being tightened.

Furthermore, higher interest rates will push more debtor households into delay or default on credit card, student loan, and mortgage payments due. While it is true that overall consumer debt is not as high as it was before the Global Financial Crisis, that is because income and wealth are more highly skewed toward the rich—who are doing just fine. Higher gas prices and interest rates are going to affect those who were already struggling with the affordability crisis that doesn’t concern Trump.

Why, then, raise rates? Because the Fed continues to abide by the erroneous belief that monetary policy somehow works as follows: when inflation picks up (no matter the perceived cause—excessive COVID relief payments, higher tariffs that raise prices of imports, or skyrocketing gasoline, diesel, fuel oil, and LPG prices) prompt action by the Fed to increase borrowing costs is necessary. This is not based on the belief that consumer spending as well as investment spending by firms is very interest-sensitive, because the evidence is overwhelming that they are not.

Rather, the Fed believes in the fairy dust story that expectations make it so: all you have to do is really, really, believe in fairies, and your wishes do come true (see here and here).

Fed rate hikes do not work through the interest rate mechanism but instead by changing the expectations of inflation by demonstrating a resolve to fight inflation using tools that are demonstrably impotent for fighting inflation. All that matters is that expectations fairy: if we will believe that the Fed is fighting inflation for us, and we believe that the Fed can lower the inflation rate, then poof—inflation disappears.

Of course, the higher interest rates are going to cause a lot of defaults on debts, repossessions of cars, evictions from houses, and troubles in the financial sector, because those bad debts are the assets of our banks, money markets (including private lending—already looking like it is in a death spiral), and pension funds. But that is a small price to pay to please the inflation fairies before which our Fed governors kneel.

While Trump, the quintessential property developer, wanted Kevin Warsh to take over the Fed and lower rates, there’s now no chance of that happening. Trump’s mistaken war has left Warsh out on a limb—he might not be the only one on the Board that resists rate hikes, but he will be in the minority. Trump’s war plus his attack on green alternatives have ensured that rising prices of oil and all its essential derivatives (including, most importantly, fertilizer) have ensured that higher and rising prices are baked into our future.