The Fed Suffers From Old World Rate Thinking

by: ClearFish Research

A fair portion of the supposed inflation we have today is from the increase in oil prices. The fed is still contemplating increasing interest rates in order to stem the rise of inflation. That means essentially that they are trying to stem the rise in oil prices by raising interest rates. Will that work?

In a word: No!

The theory behind it is that rising interest rates inhibit general economic activity, lowing economic activity across the board, and thus stemming inflation. But economic activity today is pretty much segregated from the oil sector. About 85% of GDP depends on electrical energy, with the remaining 15% dependant on oil/gas.

That's vastly different from the 1970's, where 67% of GDP depended on oil/gas. Now, some of that electrical energy has recently shifted to natural gas, but it's still mainly coal and nuclear.

Raising interest rates to stem the tide of rising oil prices is a blunt instrument (understatement). High oil prices to stem the tide of high oil prices is a sharp, pointy instrument.

A similar argument can be made for medical expenses, currently 15% of GDP. How does raising interest rates prevent people or companies from spending money on sickness? It shouldn't, and it doesn't. It just makes them more miserable in other areas of their lives.

Of the big three, that leaves housing, where one can make a pretty good argument that the mission has been accomplished.

Pulling those out, core inflation is just above the fed governors comfort zone. But the pain from getting smacked by the interest rate club takes a year or so to register, and the fed has done a pretty nice job of overshooting in the past.

Some of the governor's get these points, but we (and the market) are surprised that some of them do not.

Interest Rates, 1989-present:

Interest Rates