There are many ways the FOMC could be wrong…

Since it’s late on a Friday, I thought I might share some quick thoughts about the week.

I wonder, more than usual, about the disconnect we have between deflation and the Federal Reserve’s anti-inflationary actions. It’s hard to reconcile the Fed’s rhetoric with the real prices of commodities.

One can only draw so many conclusions: perhaps the Fed is right and everyone else is wrong. This suggests that rates need to be appreciably higher and stay that way for a long time. Or, the Fed may be wrong and many others are right: inflation has already peaked and reversed but higher rates are already causing real and unnecessary suffering; Keep tight but increase unemployment, slow consumer spending, and possibly trigger a recession.

There is a real possibility that the Fed’s diagnosis is correct. However, this will be known only in the fullness of time, when inflation is controlled and the economy does not suffer too much from healing.

This presents a far less attractive scenario than its opposite: that the Fed is wrong and adopting a deeply misguided policy.

I don’t want to be reprimanded on this issue. So instead, let’s consider a more provocative discussion. As a thought experiment, let’s see if we can break them down in terms of understanding the Federal Reserve’s current situation or what an appropriate response should be. Let’s break it down into five broad categories:

1. The Fed is wrong about inflation, its magnitude and/or direction.
2. The Fed is right about inflation but gets the underlying causes wrong.
3. The Fed is right about inflation but lacks the right tools to deal with the 2020 inflation cycle.
4. We don’t know if the Fed is right about anything – economics is a squishy and imperfect soft science at best.
5. The Fed is indifferent to inflation, but is aggressive in protecting its institutional reputation.

You could write a treatise on each of these bullet points. The impact of each error is significant. Instead, think of them as a jumping-off point for further discussion. What is already reflected in stock and bond prices? Is consensus usually formed early or late on these types of issues? If the FOMC is right, how long will it be before we know? Before inflation decreases? Before the rate drops?

Regardless, it’s a worthwhile exercise to wargame Fed actions, and consider what they could mean for your portfolio and/or personal finances.

in the past:
Behind the Curve, Part V (November 3, 2022)

When Your Only Tool Is a Hammer (November 1, 2022)

Why is the Fed always late to the party? (October 7, 2022)

Who’s to Blame for Inflation, 1-15 (June 28, 2022)

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