Inflation is 1.6%: So Let’s Tighten

New CPI numbers are out this morning with headline CPI coming in at 1.8% and core CPI at just 1.6%. The Fed generally uses core CPI (which excludes food and energy prices) when it makes monetary policy as it is less volatile and more indicative of long-run inflation. Last month’s core CPI was 0.2% as was this month’s. On a year-over-year basis, the indicator fell from 1.7% in May to its current 1.6%. Yet, what have markets spent the last month talking about? When the Fed will start to tighten.

This continues to make no sense and has not made any sense for years now.

The Fed has a goal of 2% inflation. When inflation is less than that 2%, the Fed should instill looser monetary policy to raise it. When inflation is below 2% and unemployment is high, this should be a no-brainer. At the very very least, it shouldn’t be talking about when it will instill tighter monetary policy.

If the Fed were really sticking to its goal of 2% inflation, it would overshoot and undershoot it a relatively equal amount as it attempted to hit that target exactly. Instead, the Fed has consistently undershot its goal. Inflation has been below 2% for years now. Meanwhile, unemployment sits at 7.6%. There’s a real human and economic cost to the Fed’s persistent committment to undershooting its 2% target. Its talk over the past month of tapering has already raised mortgage rates. But let’s continue to talk about tightening with inflation coming in under target. That makes perfect sense.


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