The Federal Reserve’s fight against inflation, which is at its highest level in 40 years, is a source of much controversy.
There are those who believe that by raising interest rates so aggressively over the past few months, the central bank is doing what is necessary to tame the rising prices of goods and services.
“Biggest Political Mistake”
But there are also those who believe the Fed has failed and, if it continues, risks creating an even bigger problem than the one it is trying to solve. This latter camp is beginning to make itself heard more and more.
Not surprisingly, the Fed hiked rates by 75 basis points at the end of its currency meeting on Sept. 21 and said it expects more hikes. The fed funds rate is in a range of 3% to 3.25% and is expected to increase by 4.5% by the end of 2022.
“The last two years [are] one of the biggest policy mistakes in the Fed’s 110-year history by staying loose when things were booming,” Wharton Professor Jeremy Siegel told CNBC Sept. 23.
The video of the interview went viral. On social media, it provokes a lot of comments, often unfavorable to the Fed. Siegel is visibly very angry, and you can tell from his tone. He is very lively.
“When all commodities are going up rapidly, Chairman Powell and the Fed said, ‘We don’t see inflation. We see no need to raise interest rates in 2022.’ Now, with all those commodity and asset prices falling, he says, “Stubborn inflation requiring the Fed to stay tight through 2023.” Makes absolutely no sense to me, way too tight!” Siegel added.
For Siegel, inflation has started to ease. He notes that oil and commodity prices have started to fall, finding themselves at levels seen since Russia’s February 24 invasion of Ukraine. Home prices also fell, he said.
“The only thing that is not going down is wages, and by the way, wages are in catch-up mode. Don’t pretend they’re driving inflation, they’re lagging behind inflation. I mean, workers are trying to get a little bit back on how high inflation is,” Siegel said.
“Why is he charging these workers, the white-collar workers, when all other commodity prices are going down,” he continued.
“I think the Fed is just way too tight. They, on the other hand, are making the exact same mistake they made a year ago,” Siegel said.
He therefore warned that if the Fed continues its aggressive rate-hiking policy in 2023, “you can make sure there’s a big recession on the other side.”
“I am very upset. It’s like a pendulum. They were way too easy until 2020 and 2021 and now we’re going to be really tough guys until we crush the economy. “I mean, that’s totally fair to me, bad monetary policy would be an understatement,” Siegel ranted.
Elon Musk, the richest man in the world and CEO of Tesla, clearly shares the criticism of the Fed and the doomsday scenario painted by Siegel. In fact, he commented on Siegel’s video that he had hit the nail on the head.
“Siegel is obviously right,” Musk commented.
Musk’s positioning isn’t really a surprise, as the tech tycoon warned in early September that a 75 basis point, or 0.75%, rate hike was likely to result in deflation. He reiterated that warning just days before the Fed announced its decision.
Deflation is the opposite of inflation. It is characterized by a continuous decline in the general price level. It may encourage households to postpone their purchasing decisions while waiting for further price declines, economists say. The consequences can be devastating as overall consumption plummets. Then companies that can no longer sell their products reduce production and investments.
Deflation in particular can lead to a deterioration in the financial situation of borrowers. That’s because the real, or inflation-adjusted, cost of debt increases because loan repayments are generally not indexed to inflation. So companies are less able to invest and households are less able to buy and consume the essentials.
Musk believes the Fed is very slow to respond to the risks threatening the economy.