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Is the Fed ‘going rogue’? Calls heat up to back off quest for 2% inflation


For at least a decade, the Federal Reserve’s position that a 2% inflation rate is where the economy best functions has been taken as gospel. But with a recession potentially on the horizon and the Fed continuing to slam on the brakes, calls are rising that the central bank should re-examine what has been essentially an arbitrary target and instead focus on conditions as they are evolving now. In a CNBC appearance Thursday, Barry Sternlicht, the head of Starwood Capital, which manages $125 billion for clients, called into question the 2% target as part of ongoing criticism he has leveled at the central bank. “What they want to do is clearly suicide,” Sternlicht said on ” Squawk Box .” Of the inflation goal, he said, “It will be very hard to get it to 2 [percent] and it’s not necessary. I think the Fed doesn’t appear to understand the ramifications of what they’re doing.” Markets expect the Fed to raise its benchmark interest rate another half a percentage point at its December meeting. That would take the fed funds rate to a range of 4.25%-4.5%, its highest level since late-2007. Policymakers say the moves are necessary to quell inflation that still is running near the highest level since the early 1980s. Others aren’t so sure. ‘Going rogue’ “As far as 2% is concerned, I think it’s stupid,” said Jim Paulsen, chief investment officer at Leuthold Group. “They’re on a rogue policy, disconnecting themselves from any information on the ground. For the life of me, I can’t understand it.” Paulsen and Sternlicht aren’t the only critics of Fed policy. Wharton Business School professor Jeremy Siegel has said he thinks the Fed’s persistent rate hikes are pulling the economy into recession , as have a host of other market experts who have spoken up lately. For his part, Paulsen said the Fed is ignoring a multitude of signs, from plateauing Treasury yields to falling commodity prices to other leading indicators, which collectively fell another 0.8% in October and are pointing to a high probability of a recession ahead, according to The Conference Board. “The 10-year [Treasury] is clearly saying, ‘Were done, Fed. We know you’re going to raise rates in December, but we’re not going there. Commodity markets are saying we’re in deflation. [The Fed is] ignoring market signs,” Paulsen said. “For the Federal Reserve to say ‘we’re don’t care about any of that’ truly is the definition of a Federal Reserve that is going rogue.” Paulsen even raised the prospect of congressional intervention should the Fed go too far and drag the economy into recession. Sen. Elizabeth Warren (D-Mass.) has been among the central bank’s biggest critics, and has said the obsession with inflation will cause too much pain in the labor market and a loss of jobs. “If they cause a needless recession, or even a deeper-than-needed recession, I wonder if both sides of the congressional aisle will convene a session to discuss how much autonomy the Fed will have,” Paulsen said. “Should we tie them to certain parameters they should abide by?” History of a mandate The origin of the 2% target isn’t even exactly clear. One account traces it to a late 1990s remark from a New Zealand central banker. Another more official version, from the San Francisco Fed , dates it to around the time of the financial crisis, when some Fed officials wanted to make the target even lower. Whatever the source, the level was codified in 2012 under former Chairman Ben Bernanke as the way to gauge the price stability end of the Fed’s dual mandate to achieve full employment and steady prices. It’s been adopted almost universally, at least among developed nations, as the gold standard for price stability. Despite its seemingly arbitrary history, the 2% goal still has supporters on Wall Street. “To get to price stability, you do need to have a level where you consider price stability to be reached. It’s helpful for the market, it’s helpful for consumers,” said Quincy Krosby, chief global strategist at LPL Research. “You need guardrails. There are too many moving parts in the market. … While it may not be a perfect level, it may not be an easy level to reach, it gives you a grounding and something where central banks can talk with one another.” Achieving a steady 2% inflation rate, however, has proven elusive for the Fed. For much of the post-financial crisis period up until the Covid pandemic, inflation had undershot the target, a product of globalization, changing demographics and weak demand. Some Fed critics then had encouraged it to raise the target but for a different reason — to gin up inflation expectations so officials would have more policy room in the event of a crisis. Paulsen said his research shows that when inflation expectations are higher the economy has performed better, with the 1990s, when the annual rate held near 3% and the economy boomed, as a prime example. ‘The gold standard’ for policy But Fed Chairman Jerome Powell and most of his colleagues have rebuffed calls to raise the goal. At the same time, the Powell Fed also has acknowledged that 2% can be a moving target, going so far as to adopt a revised policy framework in September 2020 that said it would tolerate higher inflation in the interest of “full and inclusive” employment, a move that came amid protests over racial inequality in the U.S. Still, there’s little expectation that officials will change their target even at a time when inflation is pointing lower and economic growth is teetering. “You’ve got to create a dynamic that gets the economy moving in that direction [of lower inflation]. Once that dynamic is in place, sometime next year, then it’s a question absolutely worth arguing or discussing,” said Steven Blitz, chief U.S. economist at TS Lombard. Blitz thinks that if unemployment eclipses 4.5%, from its current 3.7% , the Fed will have no choice but to reconsider policy. But until then, he thinks the 2% stays in place, at least as an official benchmark if less so in practice. “Understand that 2% has become kind of the gold standard, in that all the world’s central banks have focused on 2%. So if you unmoor from 2%, it’s kind of like going off the gold standard,” Blitz said. “So you can’t really take this lightly if you’re the central bank. You can’t do this willy-nilly.”

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