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What Can The Fed Do About The Price Of Food, Medicine, Gasoline, Or Rent?
Chart Notes
What the Fed Can and Cannot Do
Demand Destruction I have often spoken of demand destruction by Fed rate hikes. Curiously, the primary demand destruction is not even in the tables. Home prices are not in the CPI. Yet by hiking rates, the Fed will certainly cool the demand for housing. With decreased demand for housing comes decreased demand for things like furniture, landscaping, carpet, etc. By hiking rates, the Fed also reduces the demand to hold stocks. The price of equities drops. That also reduces the demand for housing, new cars, eating out, and travel. Elastic vs Inelastic Demand
This is why inflation Expectations theory the Fed abides by is total nonsense. People will not rent two homes if they perceive prices will rise. Nor will people stop paying rent and wait for declines in they believe prices will fall. The same applies to buying food, gas etc. Stupidity Well Anchored: Absurdity of Inflation Expectations in Graphic Form I discussed the silliness of inflations expectations theory in Stupidity Well Anchored: Absurdity of Inflation Expectations in Graphic Form CPI Percentage Weights The idea behind inflation expectations is that if consumers think prices will go down, they will hold off purchases and the economy will collapse. The corollary is that is consumers think inflation will rise, they will rush out and buy things causing the economy to overheat. With that backdrop, let’s have a Q&A. I believe the answers are obvious in all cases. Inflation Expectations Q&A
Asset Irony People will rush to buy stocks in a bubble if they think prices will rise. They will hold off buying stocks if they expect prices will go down. People will buy houses to rent or fix up if they think home prices will rise. They will hold off housing speculation if they expect prices will drop. The very things where expectations do matter are the very things the Fed ignores. Demand destruction will occur in the small subset of elastic items plus housing and stocks. Except as related to recreation and eating out, rate hikes will not impact food, energy, or shelter, the overwhelming majority of the CPI. Finally, please note A Fed Economist Concludes the Widely Believed Inflations Expectations Theory is Nonsense .
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