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You've hit on the issue the fed has - the only real tool they have to combat inflation is to kill demand. In this case, inflation is from a mix of demand because people have money and supply shocks due to covid. The feds main tool to address supply issues is to lower rates and spur investment. Problem is, they are also trying to kill demand at the same time. For now, we just have to wait for supply issues to sort themselves out.

It doesn't look like supply issues will sort themselves out though.

Many of the current shortages (industrial plant failures, food shortages) are due to climate issues. Putin isn't helping, but even without the Russia sanctions, we'd still be facing all sorts of shortages (PVC, microchips, olive/sunflower oil, wheat, mustard, water shortages blocking the Panama Canal, etc, etc).

The root cause of all that is climate change, which is worsening linearly with time, which means the backlogged impact on the economy is increasing quadratically.

Exactly. And I don't think people, in general, have wrapped their heads around what is truly unfolding right in front of us in terms of availability of cheap, accessible high density energy and the increasing impacts of the climate crisis. Energy is the economy and the economy is energy. I like the term, "energy blind" which I've heard Nate Hagens use [1]

[1] https://www.thegreatsimplification.com/

Which I think makes the argument that the Fed might not be the right entity to fight this. Powell literally says in this speech that the Fed needs to weaken labor market conditions (4th paragraph) to strengthen labor market conditions (3rd paragraph). But if the goal is strong labor market conditions and he already notes "the labor market is particularly strong", what are we all doing here? Congress should probably be the one tasked with addressing supply side issues instead of the Fed because the demand side issues aren't actually a problem that needs solving.

I think the Fed would agree with you. Powell and Yellen before him have indicated that they think fiscal policy is a much better means of addressing some of the issues they’ve tried to deal with via monetary policy, but the Fed can actually act while congress generally refuses to do so (IRA aside).

"Strong labor market" is only part of the Fed's charter. The full mandate is:

> so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates

But those goals are redundant because they all effectively mean keep inflation in check. According to Powell's own argument in the 3rd paragraph in this speech, keeping inflation in check is a goal because "without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all."

I'm not going to argue that these things are completely orthogonal, but as the current inflation crisis illustrates, we can have steep inflation and high labor participation (of course, sustaining that labor participation in the midst of steep inflation is infeasible, but most people aren't economically literate and even professional economists get it wrong with troubling frequency).

> Congress should probably be the one tasked with addressing supply side issues

Because the deficient supply of self licking ice cream cones?

https://en.wikipedia.org/wiki/Self-licking_ice_cream_cone

Something people don't appear to understand is that the fed only controls the brake pedal and maximum speed limit. They can't force more money into the economy as so many people seem to believe.

So half the time, the Fed is just some sort of con man, trying to trick the economy into doing what they want through press releases and optimistic predictions, etc.

The other time they are just slowing the economy down for good or bad reasons.

> I suspect that our largest improvement would come from investment in transportation infrastructure for goods -- all of that is super choked right now and it affects everything.

Just an FYI, any remaining supply chain issues are not really transportation related at this point. We ship several containers a month from Asia to the ports of LA/Long Beach and we haven't seen delays on either side of the Pacific in a while at this point. The other major issue we faced in 2021 was getting containers out of the port complex and on a truck to their final destination. Those delays have also been resolved at this point.

We're also seeing transportation prices come down. Trucking is still expensive because of fuel costs, but ocean rates are way, way down. The most we paid for a container from Vietnam to LA/LB last year was $22,000. Right now we're getting quotes for $4,600.

> If the way out of shortages is to invest in more production, higher interest rates will be detrimental in the face of that type of inflation.

Do you have numbers that show that's what people do when interest rates are low?

I don't have numbers - but my suspicion is that they mostly just speculate on asset prices.

Where was all the investment in the last 20 years that low interest rates should've brought on?

What it did bring on was companies borrowing money to buy-back their shares to return >100% of profits to investors.

And don't even get me started on how negative real interest rates are a negative wealth tax.

That's why they said "IF the way out". It seems like OP is asking for exactly the same numbers you are - do we need to invest more in making sure things are available/produced? Or will more money just lead to more demand in ways that make things worse like how you've described.

Honestly, I do agree with the GP.

> Do you have numbers that show that's what people do when interest rates are low? I don't have numbers - but my suspicion is that they mostly just speculate on asset prices.

I don't know either. I agree with their analysis that we've had an exuberance of speculation on rising assets during a time of unprecendented low interest rates. It just also seems unlikely that rising interest rates will facilitate additional investment towards critical shortages. Maybe this is a problem for Congress more than the fed, I don't know. Would love to hear others opinions.

Yea, it strikes me as the sort of situation where monetary policy does somewhat intentionally live in a vacuum compared to more general policy. Changing the interest rate doesn't dictate what companies or people do with the money they're borrowing/not lending at that rate.

The Fed generally has pretty coarse tools. Whether the increased monetary supply is spent on "good" or "bad" things is up to more general policy choices made in other parts of the government.

> Whether the increased monetary supply is spent on "good" or "bad" things is up to more general policy choices made in other parts of the government.

If we want to "make money" and "increase GDP" - lowering interest rates does appear to do that.

But there's no reason you can't "make money" and "increase GDP" and also actually lower productivity and living standards.

Imagine an economy where 90% of the economy is people buying land from each other on debt.

If suddenly the price of money drops 50%, and people can afford to pay 50% more for land (and do) - all things being equal - GDP increases by 50% * 90% = 45%.

If everyone realizes how much money they can make doing this instead of whatever the other 10% of the economy is - say actually working the land to farm apples - then real productivity can drop 100% to 0 - and you still "increase GDP" and people still "make money".

At the same time - maybe everyone dies of starvation shortly thereafter?

I'm not arguing this is actually happening - especially to this degree - but it is easy to see that it is at least possible*.

Well, what you are describing is actually what happens during economic depressions. People who need to eat don't have money so economic activity is diverted from producing food even though any sane individual would think that producing enough food is the highest priority for any civilization.

What I personally find strange is that there are economic schools of thought that just axiomatically conclude that nothing is wrong and these people are rightfully starving even though there are economic schools that prevent starvation and end up with superior output.

>And don't even get me started on how negative real interest rates are a negative wealth tax.

You mean it is an implicit tax on liquidity which isn't to be confused with wealth as money is merely a claim to wealth and not wealth itself.

This is why the Inflation Reduction Act is so effective. It attacks inflation from both ends. It raises taxes more than it increases spending, so it reduces the money supply. OTOH, it encourages investments in green energy, likely leading to a substantial reduction in the cost of energy in the long term.

The CBO only measured the first effect, but the second is much more important, IMO.

It doesn't do much for housing, but that's mostly a local issue (aka zoning).

> This is why the Inflation Reduction Act is so effective.

It's not very effective because the sum difference is barely a drop in the bucket. It's not enough to significantly impact inflation at the scale of the US economy. Only the Fed's rate hiking is going to do that at this point, as they intentionally attempt to cause a recession to destroy demand.

Compare just the annual US Govt debt accumulation versus the difference between spending increase & tax increase in the act. How much new debt is the US going to take on this year? The Inflation Reduction Act, like so many government programs, warns you that it's a lie and a joke right in the title. The moment they chose that name, they were telling you everything about it: it wasn't an inflation reduction act.

They championed it also as though it was a huge deal for climate change, it's not, that's a lie as well. Climate change is overwhelmingly global as an issue, there's absolutely nothing they can do to meaningfully offset the expansion of emissions elsewhere around the world. If they were serious about climate change, they'd have named the act: Stop China From Building Another Hundred New Coal Power Plants Act.

Much of the rest of the world is refusing to do anything about climate change because the US was doing nothing. That excuse has disappeared, so the IRA will have a multiplicative effect.

10s of billions of dollars have been announced for new battery plants to be built in the US and Canada since the announcement of the IRA. It's already having a massive effect.

> It raises taxes more than it increases spending, so it reduces the money supply.

Taxation should be thought of separately from monetary policy. To put this into perspective, M2 money supply grew from 15.33T on Dec 31 2019 to 21.71T on July 31 2022, a growth of 41% in two years ($6.38T). In 2019 it grew 6.6%. The net revenue of the Inflation Reduction Act is 324 billion over over ten years. It's just not in the same ballpark

> OTOH, it encourages investments in green energy, likely leading to a substantial reduction in the cost of energy in the long term.

Subsidies and investments don't necessarily lead to a reduction in costs. Think about the sectors that have the most public spending in the US (health care through medicare and medicaid, education, real estate via fannie/freddie, etc). These are the fastest growing industries in terms of prices

https://ycharts.com/indicators/us_m2_money_supply

https://taxfoundation.org/inflation-reduction-act/

Energy is fungible. Medicare, education and real estate aren't. Medicare and education are strongly impacted by Baumol's cost disease.

> Medicare and education are strongly impacted by Baumol's cost disease.

I disagree. Healthcare isn't necessarily labor intensive. New technologies should make care cheaper. If anything labor efficiencies have made the actual labor required of medical care a lot less. Doctors used to make house calls and spend more time with you. Now you go into a doctor's office, wait up to an hour sometimes, sit in a room, have some lower paid aids take your vitals, get your information, etc and you end up seeing the doctor for 15 min. Doctors see about 20 patients a day and spend normally 15 minutes per patient. Compare that to 50 years ago and you can bet that there have been "labor efficiencies" since that time. That doesn't even account for tele-medicine for routine stuff like getting ear drops for a sick child.

As for education, teachers aren't paid a lot, all the new costs are administration. Education expenses did not grow proportionally to educator's salaries, but far exceeded them, so your theory doesn't hold up.

https://www.excel-medical.com/a-typical-primary-care-physici...

In my jurisdiction, 71% of the education budget goes to teacher salaries, so education expenses couldn't have grown substantially faster than teacher salaries.

And Baumol doesn't require salaries going up, it works just fine if salaries stay constant while the price of consumer goods goes down.

Here's an alternative explanation that explains the rise in both education and health care as well as the drop in the price of consumer electronics: the customer doesn't pay.

In both health care and education, the final customer often does not pay. When I go to a doctor and ask them how much something will cost, I get bewildered looks. They rarely hear that question. I don't pay, my insurance pays and I pay some co-pay. Same thing for education. I'm pretty much stuck with my local school district, or if its college, I get subsidized no questions asked student loans.

But compare that to something that's paid out of pocket by the consumer. Consider something like Lasik surgery. It costs about $2-3k per eye an. Pretty incredible considering its relatively new procedure. I can't find a single outpatient surgery covered by insurance that costs that little. Cosmetic surgery is similarly cheap. And the difference is that the Lasik surgery is paid by the consumer and most people would shop around, ask about prices, etc. No subsidized Lasik loans, no insurance coverage, just straight forward pricing.

You're helping my argument, not yours. :) The energy market is different/better than education and health care, so subsidies are more likely to flow to the consumer.

You are right. There are two sources of inflation:

1. Inflation caused by increasing demand (often due to more money coming into the hands of people/companies/institutions)

2. Inflation caused by reduced supply (often due to logistics, productivity drops and reduced trade)

With covid, we had both. At this point, we have far too much money in the hands of speculators and too few producers of goods and services in the world.

The Fed can use interest rates to reduce demand. But they will also reduce supply because many producer businesses will go bust.

I know this is heavy handed but the real policy help at this point is to ensure that there is more money to be made in real production and less in speculation. All the real estate agents, flippers and day traders need to be sent to factories to produce actual things.

> how much of the inflation is caused by lack of supply for relatively inelastic commodities. If the way out of shortages is to invest in more production, higher interest rates seems detrimental in the face of that type of inflation

I'm no economist, but is it really a problem in practice?

Shouldn't stuff with both high prices and inelastic demand be a really attractive target for investment? If you can produce that stuff (before the situation changes), you're almost guaranteed to be able to sell it and at a high profit. So getting capital for it should be relatively easy.

I'm sure higher interest rates will have some effect, but it seems like it wouldn't be enough to discourage investment that much.

Given the large deficits we've run since the 80s and the lack of inflation during those 40 years, I'm going to go ahead and guess that the prime suspects for inflation are covid related supply issues and logistics issues. But since the labor market is tight, you know the fed will not miss the chance to crush workers, so expect rate hikes for a long time.

The deficit grew to twice what it was after 2008, the scale of spending is quite a bit different than the recent past (trillion dollar bills are the new $100 billion in the US). The same spending pattern has happened across western countries around the world who are facing similar inflation (and supply side) issues, so the pressure has been global.

https://datalab.usaspending.gov/americas-finance-guide/defic...

Everything plays a role even if it may not be the primary one.

We weren’t doing QE until 2008 and the scale of the deficit is quite a bit different.

CPI is such a wack metric. It doesn’t really measure so much the value of the USD as it does “prices of certain things”.

> I'd like to find numbers which illuminate how much of the inflation is caused by lack of supply for relatively inelastic commodities.

The SF Fed published a study a little while ago, "How Much Do Supply and Demand Drive Inflation?":

> Inflation has remained at levels well above the Federal Reserve’s inflation goal of 2% for over a year. Separating the underlying data from the personal consumption expenditures price index into supply- versus demand-driven categories reveals that supply factors explain about half of the run-up in current inflation levels. Demand factors are responsible for about one-third, with the remainder resulting from ambiguous factors. While supply disruptions are widely expected to ease this year, this outcome is highly uncertain.

* https://www.frbsf.org/economic-research/publications/economi...

NY Fed estimates about 40% was supply chain issues. 60% was demand side.

https://www.marketplace.org/2022/08/25/what-was-the-main-dri...

The SF Fed:

> Inflation has remained at levels well above the Federal Reserve’s inflation goal of 2% for over a year. Separating the underlying data from the personal consumption expenditures price index into supply- versus demand-driven categories reveals that supply factors explain about half of the run-up in current inflation levels. Demand factors are responsible for about one-third, with the remainder resulting from ambiguous factors. While supply disruptions are widely expected to ease this year, this outcome is highly uncertain.

* https://www.frbsf.org/economic-research/publications/economi...

Why wouldn’t it be both the (considerable) expansion in money supply and shortages? At a 30000 foot view, price level is determined by money supply divided across the finite set of goods and services.

> taxes on properties which are not lived in by their owners

IMO that's the real key to the real estate problem and it should be an escalating process.

Property you live in = 1 rate

1 property you own but don't live in = slightly higher rate (family vacation home perhaps)

All other property you own but don't live in = much higher rate (this is the business tier)

What if you're renting that property out as a long-term-rental? Jacking up taxes on that is pretty much just going to penalize renters (I'd guess, anyway), which is not really fair, as they're (again generalizing) on average poorer than property owners.

I'm not sure what the solution is. There's probably a tax component to it, but I think second order effects need to be carefully considered.

Somewhat the point. With a tiered approach, the costs for a person with a single rental home become lower than the costs for a business buying up the block.

If it forces sales, you get more home inventory and lower prices.

Why would the landlord not push the increased tax expense onto the renter?

Landlords in supply-constrained cities are able to charge the maximum rent their tenants can afford; and increase in landlord costs is thus not able to be passed onto the tenant, because if the tenant could bear more they would already be charged that much.

This is in aggregate, of course; individual landlords may charge less than what individual tenants can bear but across the rental market, landlords extract monopoly rents already.

That's why you will find rents increase proportionately to incomes, not landlord costs. This is highly apparent in New Zealand, where mortgages are not fixed rates for more than 5 years; interest rate changes have little to no impact on rents, but supply and tenant incomes do.

People can and will downgrade to absorb costs.

> ...individual landlords may charge less than what individual tenants can bear...

I lived in a supply-constrained city once and my landlord, a nationwide public company, could have charged me significantly more without prompting me to move. I am one individual though and you called out that exception.

However, had I been priced out of the unit in which I lived I would have found a smaller and/or less desirable unit at lower cost. Rental units vary in size and quality.

The existence of individuals who can pay more and the non-fungibilty of rental stock makes me suspect that such taxes will simply be passed on.

The theory sounds good, but in practice we can see that rents stay quite stable as a ratio of income, and not as a ratio of interest rates, or house prices, or anything else that would be a landlord cost. Check out the rent to income ratio in your own municipality and compare to, say, rent-to-interest rate, or rent-to-property-price. Landlord costs only get passed down when there is significant room to increase rents in the tenants income and there is insufficient supply to handle the number of potential tenants.

Thank you for the discussion. I appreciate the well-made points.

> To me, it seems an important distinction whether "excess" cash is going towards buying elastic goods/services (peloton cycles, fancy grills, RTX3080 for gaming, etc) or simply fighting over shortages of inelastic goods (baby formula, bacteriostatic water, shipping space, gasoline, etc).

I agree, but I think I lean in the opposite direction as you do.

It's relatively easy to produce more Pelotons, grills, and (to a lesser extent) RTX3080s.

It's difficult to produce more wheat and houses. When the price of housing is going up nationwide faster than ~4%, that's probably time to increase interest rates, because supply elasticity won't be coming to the rescue. By the time it filters into rent prices, it's too late and you're doomed to overshoot.

Increasing interest rates isn't going to reduce rents. And suggesting it reduces ownership prices misses the point. Sure, maybe list prices will go down but it won't reduce the cost to the buyer.

I have the same thought. Looks like Fed, like every other institution, is following sort of "KPI" and may or may not care about the implications.

I would like to add housing to your list of inelastic items.

Excellent analysis.