The path to 2%

Question: Why is the Fed so determined to bring down inflation?

Donald Ellenberger: Fed Chair Jerome Powell has said very forcefully that the Fed will absolutely not budge from their 2% inflation target, but really what's so special about 2%? What's wrong with 3% or 4% inflation? And isn't this the same person who told us that inflation would be transitory and was dead wrong? So why should we believe Chairman Powell this time? Well, it's because we need to not only listen to what the Fed says, we need to watch what they do. Back in March, when Silicon Valley and some other banks imploded and sparked a system-wide bank liquidity crisis, the Fed still went ahead and hiked rates 25 basis points. I've been doing this a long time and I never remember the Fed hiking rates during any kind of a financial crisis. And despite the fact that the Fed staff of over 400 PhD economists is forecasting a recession later this year, the Fed not only hiked in March, they did it again in May, and they just signaled that they may hike two more times later this year. So that's how serious the Fed is about getting inflation back down to 2%. Now, part of the reason the Fed is so fixated on their 2% inflation target is because they desperately want to reclaim the inflation credibility they lost when they thought the inflation spike after the Covid recession would be transitory, and they just turned out to be completely wrong. But I think there's another equally important reason the Fed is willing to risk a recession to get inflation all the way down to 2% and not stop at three or 4%. So here's a stunning fact. 57% of the people in this country cannot afford an emergency expense of 1,000 dollars. For over half the people in this country, high inflation could mean deciding whether to fill up their truck at the gas station or fill their prescription at the drug store. And yes, certainly a recession would cause the unemployment rate to rise from three and a half to maybe 6.5%, and it would hurt the 3% of people who lose their jobs. But if the Fed lets inflation stay high, it doesn't just hurt 3% of the population, it hurts 100% of the population, it hurts everybody. And I think that's a big reason why the Fed is so determined to get inflation all the way back down to 2%, even at the very real risk of a recession.