New York, NY, InfraCap Market Update - Recent press reports indicate that certain Trump advisors are drafting proposals to weaken the independence of the Fed. These proposals may seem reckless to many, but they are failing to recognize that Fed policy over the last 20 years has been a disaster. Specifically, the adoption of a rigid 2% inflation target has been terrible for economic growth and the middle class. Economic growth after the adoption of the target has averaged approximately 2% versus an average of over 3% in prior periods. Real and nominal wage growth also plummeted since the adoption, resulting in lagging middle-class purchasing power. The adoption of the target in the early 2000s triggered 17 Fed rate increases in a row that preceded the great financial crisis. Academic papers have shown that the 2% target greatly exacerbated the depth of the great recession.
The current Fed has admitted that it has no ability to forecast inflation, which we all know is true after the Fed created the failed "transitory" theory of inflation. If the Fed has no ability to forecast inflation, then it is inevitable that the Fed will dramatically under and overshoot its overly precise inflation target. The Fed is so rigid and bureaucratic that it refuses to review its arbitrary 2% target since it believes that it might damage Fed credibility.
The Fed needs to completely overhaul its policy framework in the wake of the 'transitory" disaster. The UK is currently in the process of executing a policy overhaul with Ben Bernanke advising on the process. The Fed's revised policy framework should create a flexible inflation target of 2-3% without specifying a single potentially flawed index such as the PCE Core index. In addition, the framework should specify an employment and nominal wage target to reflect the dual mandate of the Fed.
Eliminating the independence of the Fed is an inferior approach to revising the Fed's policy framework, but is superior to allowing the Fed to continue to pursue its current overly rigid policy. The Fed's focus on the highly distorted PCE Core index is a flawed approach vs. looking at a variety of inflation gauges, including both headline and core inflation in PPI, CPI, and PCE. If the Fed had followed a broader group of inflation indices, it never would have made the "transitory" error as PPI was running at double-digit increases at the time of that declaration. Ideally, congress would initiate a policy review through its limited oversight of the Fed, but given the Fed's intransient nature, it may require more radical moves by the Executive branch to trigger reform.
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Please review publications supporting our thesis that the Fed's 2% target made the great financial crisis worse.
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