By Eric Peters, CIO of One River Asset Management
“It’s a good time to retire that word,” said Powell, seated comfortably next to Yellen. Senator Toomey had asked how long inflation must run above target before the Fed decides, maybe it’s not so “transitory.”
The Senate Banking Committee’s Ranking Member appeared as surprised as virtually every Wall Street economist that two consecutive years of 15% deficits, financed by Jay’s magic money machine, lifted inflation in ways that have begun to appear persistent.
“I think what we missed about inflation,” Powell admirably conceded, “was we didn’t predict the supply-side problems, and those are highly unusual and very difficult, very non-linear, and it’s really hard to predict those things, but that’s really what we missed, and that’s why all of the professional forecasters had much lower inflation projections.”
No doubt our Fed Chairman is right.
There’s not an economic model in the solar system that could have forecast today’s extraordinary inflation without first predicting the “highly unusual, very difficult and very non-linear” supply constraints plaguing the global economy.
But that is all now understood. What is not known is how monetary policy can or should be used to alleviate these supply constraints.
For nearly half a century, the Fed reaction function was nearly linear. When the system deviated unacceptably far from stability, equilibrium, the Fed added new monetary tools. Forward guidance. Average inflation targeting. Whatever it took.
And it is possible that once the invisible hand restores global supply chains, markets and economies will return to their familiar states. But having just retired the notion of transitory, the entire system appears to be moving towards a non-linear mode.