Everything the Fed Knows About Inflation Is Wrong

The Pitch: Economic Update for April 18th, 2024

Friends,

We’ve been saying since at least last July that one of the biggest drivers of inflation in America right now is the high cost of housing. And because the Federal Reserve is keeping interest rates very high in a misguided effort to “cool down the economy” and bring inflation down, that means the Fed is forcing up the price of housing — those high interest rates make it more expensive to borrow money which makes it harder to build housing and drives up the costs of mortgages and therefore rents. It’s a nasty vicious cycle: higher rates are driving higher costs.

That’s right: the Federal Reserve’s primary mechanism to push inflation down is actually pushing inflation higher — as we saw in last week’s inflation report. And rather than lowering interest rates to bring down the cost of housing, Fed Chair Jerome Powell is instead talking about keeping rates higher for even longer.

Harvard economics professor Greg Mankiw argues that because the Consumer Price Index “for shelter is up 5.6 percent,” that means the monthly CPI report appears “quite hot.” Housing is still the primary driver of inflation.

Because housing costs are so high, and because it costs so much money to borrow money, Americans have opted out of the housing market, and now the housing market is hurting. “Home construction activity plunged in March, as an uptick in interest rates apparently led builders to pull back on plans — especially for multifamily projects,” Axios reported this week. And all the costs associated with home ownership — including insurance and construction materials — have also risen dramatically over the past couple of years.

Redfin’s chief economist, Daryl Fairweather, told Politico this week that last week’s inflation report is “going to hurt the housing market’s recovery, but it’s hard to imagine the housing market getting much worse, because it’s already been through so much.” Fairweather explained that “We were hoping that interest rates would fall in time for the spring housing market season, but it’s already April 15, and interest rates are higher than they were a month or just a week ago,”

So Americans who want to move but are lucky enough to already own their own homes are sitting on their fixed mortgages until interest rates decline. But lots of Americans don’t have that luxury: They either need to move for economic or personal reasons, or they rent their homes. And housing is unlike almost every other item in the economy because every human being needs shelter.

It’s those Americans without secure housing who are suffering the brunt of this spike in housing costs, and as the housing inflation crisis continues into its third year, Americans who don’t own their homes are continuing to lose ground to the home-owning Americans. Renters are likely to spend a higher share of their incomes on housing than homeowners, so rent increases hit even harder than increased mortgages. When the price of a necessity like housing takes up close to 50% of your income, and the price of it is rising higher than most anything else, of course you might not feel great about the state of the economy.

These increases in the housing market are starting to cause the kind of effects that can produce meaningful, lasting consequences for the lifetime incomes of the have-nots. Just as Americans who graduate from college during recessions earn less over their lifetimes than those who graduate in boom times, Americans without shelter they can afford are in danger of falling even further behind.

Though the Federal Reserve isn’t the only cause of these high housing prices, they are contributing to housing costs with their interest-rate increases. So how can the Fed be so wrong in its approach? Remember that the Fed only has a few simple mechanisms that it can use to combat inflation, and the primary one is raising or lowering interest rates to make money more or less expensive. The conventional wisdom holds that the Fed beat back the high inflation of the 1970s and early 1980s by raising rates so high that it kicked off a recession, causing corporate layoffs and lowering their consumer demand.

But our modern situation bears no resemblance to the wage-price spiral of 40 years ago. Prices started rising when we turned the global economy off and then on again to combat the spread of Covid, and global supply chains needed a lot of time and money to return to their full strength. And now, corporations are taking advantage of those disruptions to jack up their own prices and pump their profits to sky-high levels.

This is the first time we’ve ever experienced these exact kinds of conditions, and nobody — no economist, no government official, and certainly no pundit — really understands exactly what’s going on right now, or how inflation will behave in the weeks and months to come. In his newsletter, Peter Coy acknowledges that the Fed doesn’t have a clue.

“In the absence of a strong theoretical explanation for inflation, Fed rate-setters fall back on things they can directly observe, such as price changes in various categories. This is known as data dependence, and it’s a good thing for the most part,” Coy writes. “The problem is that it’s backward-looking. The Fed and the rest of us would be better off with a theory that could reliably predict where inflation is going, not just where it’s been.”

So what needs to happen to bring those housing costs back down? JP Morgan strategist Jack Manley was crystal clear in his assessment to Bloomberg, explaining that “we’re in this funny, peculiar chicken-and-the-egg type situation where you’re not going to see meaningful downward pressure on inflation until you see meaningful downward pressure on shelter costs. And you’re not going to see meaningful downward pressure on shelter costs until the Fed lowers interest rates.”

Last week’s inflation report also saw a large spike in the price of insurance — including health insurance, homeowners insurance, and car insurance. Robert Kuttner notes that those prices, similar to housing, don’t behave like most consumer goods. “People with spare purchasing power are not ‘demanding’ more health care. Rather, the health system, including drug companies, has too much market power to rig prices,” he writes. “Rather than hiking rates, the Fed should be pressing the Federal Trade Commission for even tougher antitrust enforcement.”

But while we wait for the Fed to catch on that their current policy is making the situation worse, our leaders should encourage policies that help to bring housing costs down as much as they can. Robert Dietz, chief economist of the National Association of Home Builders, explained to Politico that “If we want to bring overall inflation down, one way to do that is to decrease the rate of shelter inflation, and the only way to do that is to build more sustainable and affordable housing.”

It’s fascinating to watch the economic mainstream slowly come around to the realization of how the economy is actually behaving — and it’s gratifying to see that the Biden Administration has understood this reality for quite some time. Unfortunately, the Fed is an institution that is designed to move slowly, which means that they’ll be the last to realize what must be done to make housing affordable again.

The Latest Economic News and Updates

Talking Taxes

President Biden delivered a by-all-accounts rousing speech in Scranton this week on un-rigging the trickle-down tax code, and making it work in favor of working Americans, and not wealthy CEOs, again.

“When I look at the economy, I don’t look at it through the eyes of Mar-a-Lago. I look at it through the eyes of Scranton,” President Biden said, adding that his proposed 25% minimum tax on billionaires was “how we invest in the country” because “we know the best way to build an economy is from the middle out and the bottom up, not the top down. Because when you do that, the poor have a ladder up and the middle class does well and the wealthy still do very well. We all do well.”

It’s important that Biden ties the tax talk directly to his middle-out economic vision because the tax code has been one of the most meaningful tools to transfer wealth from working Americans up to the wealthiest .1 percent of the economy. The current tax code is one of the biggest holdovers from the trickle-down economic era, and it plays a critical role in expanding inequality.

The Roosevelt Institute’s Elizabeth Pancotti explains the tax code’s role in spreading trickle-down across the economy. “Beginning with the Economic Recovery Tax Act of 1981 (ERTA) — enacted less than seven months into his tenure — former President Reagan slashed taxes for individuals, especially at the top end of the income distribution, and corporations,” she writes. “As his argument went, these cuts for high-income Americans and corporations, and those that followed during his administration, would trickle down, creating jobs and spurring economic growth that would lift all boats.”

For the next 40 years, presidents from both parties continued Reagan’s trickle-down tax policies. How did that work out? Pancotti explains, “Since 1980, inequality has soared. Mid–20th century progress on narrowing racial wealth and wage gaps stalled, and in some cases reversed course. Concentration and consolidation of economic power has exploded. Tax revenue, as a share of GDP, has plummeted. Corporations have shifted away from investing in innovation and workers and toward maximizing returns to shareholders,” she writes, concluding that “Mounting evidence suggests that tax cuts for the wealthy make the rich richer and have little effect on economic growth or employment.”

In fact, “a growing body of literature finds that rising inequality constrains economic growth.”

“Since assuming office, President Biden has harkened back to an earlier era of tax policy, proposing tax increases primarily levied on wealthy individuals and corporations, though only two have been enacted,” she writes. “That approach is part of a broader shift away from neoliberalism in the Biden administration’s economic agenda, which has instead favored industrial policy, worker empowerment, and marketcrafting.”

On Tax Day, the Groundwork Collaborative made a great case for raising corporate taxes as a way to fight out-of-control “greedflation” in the grocery sector, in order to “disincentivize this corporate profiteering that’s costing Americans so much.” We tax corporate profit so little now that the tax code basically begs corporations to do everything possible to report record quarterly profits (and then hand those profits away to shareholders via stock buybacks.) But with a return to a sane corporate taxation structure, and with the adoption of new tax policies that encourage corporate sustainability and responsibilities, companies would be less inclined to chase profit sugar-highs that enrich a few wealthy shareholders in the short term and ultimately harm their own long-term growth.

This kind of new understanding and communication about taxes is incredibly important to expanding the reach of middle-out economics because taxes are an essential way that governments dictate who wins and who loses in their economy. Rewiring the tax code to center working Americans — and not extractive corporations and centibillionaires who hoard their wealth — is an essential part of the middle-out economic project.

Working Americans Keep Winning, and Trickle-Downers Keep Fighting Workers

“Employers added 303,000 jobs in March, the 39th straight month of growth,” the New York Times reported on Friday. “The unemployment rate fell to 3.8 percent.” Americans are putting those paychecks to good use, too, as the US Census reports that American retail sales for March were “up 0.7 percent from the previous month, and up 4.0 percent above March 2023.” Those increased sales will create more jobs in a virtuous economic cycle.

This is incredibly good news, obviously, but we all know that it’s not the quantity of jobs that matters most, but the quantity. We need workers’ paychecks to keep growing and we need those workers to feel secure enough in their jobs that they are willing to keep spending in the economy.

There’s good news on that front, too, as auto workers in traditionally anti-union states across the south are advancing toward unionization. “Workers at a Mercedes-Benz factory in Alabama have petitioned federal officials to hold a vote on whether to join the United Automobile Workers,” Jack Ewing writes at the New York Times, calling the move “a step forward for its drive to organize workers at car factories in the South.” Those workers are voting on whether to join the UAW even as I write these words, as are workers at a Tennessee Volkswagen manufacturing plant.

Interestingly, David Dayen reports that a provision in President Biden’s environmental regulations supporting electric vehicle production in plants like the Tennessee Volkswagen plant “make it close to impossible to close that plant or shift EV production elsewhere. That robs UAW antagonists of a critical and oft-deployed argument against union drives: that the facility would lose business or have to close if the unionization is successful.”

In a bizarre act of economic self-destruction, six southern governors released a joint statement urging those auto workers to reject unionization.

At the Washington Post, Jeanne Whalen reports on the statement: “‘The reality is companies have choices when it comes to where to invest and bring jobs and opportunity,’ the governors of Tennessee, Alabama, Georgia, Mississippi, South Carolina and Texas wrote. ‘Unionization would certainly put our states’ jobs in jeopardy.’”

That’s not true, of course — it’s a trickle-down threat intended to scare workers into voting against their own best interests. The low-wage, anti-union south has long since fallen behind high-wage states that are far more receptive to unions. The data show that unions raise worker wages — especially for workers without college diplomas — by a considerable amount. We also know now that those bigger paychecks create jobs.

When you put it all together, those six governors are actually arguing in favor of their states becoming the lowest-common denominator, appealing only to extractive low-wage employers who suppress wages for everyone. In other words, they’re arguing on behalf of the wealthy few who benefit from widespread low wages, using the debunked tenets of trickle-down economics to make their case against working Americans.

Let’s see how that works out for them.

In the meantime, Florida Governor Ron DeSantis ”signed legislation that prohibits cities and counties from creating heat protections for outdoor workers,” reports NPR. Timothy Noah at the New Republic explains that this bill is a direct response to a Miami law that required employers to provide additional rest and water breaks for outdoor workers when the temperature rose above 95 degrees. It would almost be comical, if this law didn’t put workers’ lives on the line as climate change means that temperatures will continue to climb.

For 40 years, trickle-downers were able to get away with slashing job protections and blaming workers’ wages for widespread job losses because trickle-down was the only game in town. Both political parties bought into the false idea that a small handful of wealthy people were the real job creators in the American economy, and so the only political action left open for debate was some quibbling at the margins about how high it was possible to raise the minimum wage without tanking the whole economy. If you believe that raising the minimum wage absolutely kills jobs, any attempt to raise the wage is seen as a net negative.

But now that progressive leaders have a true understanding of how the economy really grows — from the paychecks of nearly 170 million working Americans — those trickle-down arguments are clearly revealed as the inhumane, anti-worker statements that they really are. They don’t sound nearly as plausible to Americans as they did ten years ago, and the threats carry much less weight. That’s the power of an economic narrative.

This Week in Middle Out

• “President Biden canceled $7.4 billion in student loan debt on Friday,” writes Zach Montague at the New York Times, adding that the cancellation relieves debt for “around 277,000 people.”
• Axios reports that child care worker wages have risen by 4.8 percent in the last year, far outpacing the 3.1 percent raises that most American workers earned. Child care costs have climbed by about 4.4 percent in the same time. “This is hardly a story about high pay run amok.” Emily Peck explains, adding that “wages are still extremely low in the industry. Rather, child care providers are struggling to attract and retain workers in these low-paying jobs.”
• “Federal regulators on Tuesday issued new protections for miners against a type of dust long known to cause deadly lung ailments — changes recommended by government researchers a half-century ago,” writes Chris Hamby. That’s not the only long-awaited regulation the Biden Administration has adopted this week: “The Biden administration on Friday made it more expensive for fossil fuel companies to pull oil, gas and coal from public lands, raising royalty rates for the first time in 100 years in a bid to end bargain basement fees enjoyed by one of the country’s most profitable industries,” writes Coral Davenport.
• Meanwhile, Lisa Davenport writes about a regulation that, happily, didn’t take decades to establish: “For the first time, the federal government is requiring municipal water systems to remove six synthetic chemicals linked to cancer and other health problems that are present in the tap water of hundreds of millions of Americans.”
• “President Joe Biden promised cheering unionized steelworkers on Wednesday that his administration would block the acquisition of U.S. Steel by a Japanese company, and he called for a tripling of tariffs on Chinese steel,” notes the Associated Press.

This Week on the Pitchfork Economics Podcast

Last week, the Democracy Journal convened a conference to discuss middle-out economics with some of the leading economic thinkers and policy wonks of our time. One of the highlights of the conference was a discussion, moderated by Democracy editor Michael Tomasky, between Civic Ventures founder Nick Hanauer and White House Council of Economic Advisors member Heather Boushey, about the past, present and future of middle-out economics. We thought that discussion was so illuminating and hopeful that we decided to present it as a special edition of the Pitchfork Economics podcast today.

Closing Thoughts

You have no doubt seen headlines about polling which indicates that the American people trust the Republican Party more when it comes to economic issues. And if you were to look only at the toplines of a Navigator poll from this week, you’d come to the same conclusion: Just 36 percent of Americans say they trust President Biden and the Democratic Party, while 47 percent say they trust the Republican Party more.

But when you dig just a bit deeper into the data, you start to see a different picture. For instance, voters are very bad at assessing the national economy, as with a recent Wall Street Journal poll that found voters rank their own state’s economy as far better than the national economy:

And obviously, the partisan divide is real — Republicans overwhelmingly trust the Republican Party with the economy and Democrats trust the Democratic Party — but the real news is the independent voters:

A full 45 percent of independent voters — and 20 percent of Democrats — say they don’t know which party is most trustworthy when it comes to economic policy. When those voters start to hear about policies, that’s when things get downright fascinating:

When presented without a party or a candidate, all of Biden’s middle-out economic policies are overwhelmingly popular, even attracting a majority of Republicans on every issue except raising the corporate tax rate from 21% to 28%, which is “only” supported by 47% of Republican voters. These issues are incredibly popular with every political party: Capping insulin prices at $35 a month, raising taxes on the rich to fund Social Security, catching wealthy tax cheats, creating free universal preschool for all 4 year-olds, and establishing a national paid family and medical leave program.

On the contrary, the trickle-down GOP budget is roundly unpopular, and Americans of all parties dislike their policies, which include cutting Social Security and Medicare, passing a national abortion ban, cutting programs like food and housing assistance and the Affordable Care Act, and giving tax breaks to the wealthiest people and corporations.

People often take to social media to despair over headlines that dwell on the toplines of polls like this Navigator outing. But when I see polling like this, I see an opportunity. It’s up to electeds, candidates and their campaigns to take every opportunity to describe the policies they’d like to enact, and the policies that their opponents would like to enact.

But that’s not all — it’s essential for candidates to explain why they want to enact the policies they support: “I want to unrig the tax system so that CEOs pay at least the same tax rate as their janitors and entry-level workers, because the revenue raised from their taxes can fund essential programs like paid medical and family leave and affordable pre-K for all. Working Americans will then have more money to spend in their local communities, creating jobs with their bigger paychecks.”

It’s that explanation part that trickle-downers perfected over the last 40 years, telling a story to voters that — even though it wasn’t true — was at least consistent. “If you raise wages, you kill jobs” is a false statement, but it’s easy to understand and it presents a clear case of cause and effect to voters.

“When workers have more money, they create more jobs with their bigger paychecks” is a true statement that actually explains how the economy really works, placing working Americans at the center of the economy.

It’s this last piece — telling a story about the economy that affirms and explains middle-out economic policies — that progressives have been very bad about over the last forty years. But led by President Biden’s example, we’ve seen remarkable progress in just four years. This is how you win over the nearly half of independent voters who have yet to make up their minds about the economy — and it’s also how you change the economic narrative for everyone.

If you want to learn more about the power of strong economic narratives, I cannot recommend the folks at Winning Jobs Narrative enough. They’re doing heroic work to change the economic conversation so that it centers the real people who power the economy, and they offer resources, research, and messaging guidance to anyone who wants to spread the word about how the economy really grows.

Be kind. Be brave. Take good care of yourself and your loved ones.

Zach