20190124 perspectives jerome powell

Why the Fed should be worried about deflation

Updated 5:03 PM ET, Thu January 24, 2019

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Stephen Moore is a senior economic analyst at CNN. He is an economist at the Heritage Foundation and co-author with Arthur Laffer of "Trumponomics: Inside the America First Plan to Revive Our Economy." He was an economic adviser to the Trump 2016 campaign and is an unofficial adviser now. He is a founder of The Committee to Unleash Prosperity. The opinions expressed in this commentary are his own.

Perspectives stephen moore

The economy is booming. Yet the Fed seems to be doing everything in its power to undermine growth, and has set us on a path toward deflation.
After the Fed's rate hikes in September and December, and the central bank's announcement that more interest rate hikes were on the way in 2019, the stock market had its worst December since the Great Depression. Many have defended Fed Chairman Jerome Powell's rate hike decisions, saying he wants to prevent the economy from overheating. But the Fed has in fact created a very dangerous deflation in prices.
Some economists have publicly disagreed with me about this stance, including Nobel prize winner Paul Krugman — yes, the same economist who said the day after Trump was elected that the stock market would "never" recover from a Trump presidency. One Washington Post columnist told CNN "there is no deflation" in prices.
But sure enough, the December Consumer Price Index number released earlier this month showed that prices declined by 0.1% over the previous month. Granted, it was a small decline over a period of just one month, but when prices fall, that's called deflation.
But the most serious sign of deflation I am warning about is the much sharper decline in commodity prices — silver, steel, copper, soy beans, cheese, oil and so on. The standard measure of 19 major commodity prices (the CRB index) shows that commodity prices fell by nearly 13% from Jan. 2, 2018 to Dec. 31, 2018, and by around 12.5% in 2018 since the Fed's September interest rate hike.
Over the past year, the price of oil is down around 19%, silver around 11%, soybeans at about 8%, cheese nearly 8%, steel over 5%, hogs 17%, and aluminum nearly 16%. Ask an oil producer or a soybean farmer if they think there is inflation in prices. They are getting clobbered by the declining prices.
Some of this, such as the low soybean, silver and platinum prices, can be due to the trade war with China, for sure. But the trade war doesn't account for the across-the-board reductions in prices. Declines in commodity prices are reported every day and are a reliable lead indicator of where consumer prices are headed.
    As we learned during the Great Depression, deflation can be even more destructive than inflation, as it leads to a shrinkage of the economy.
    Commodity prices are falling because we have too few dollars chasing the increasing production of a strong American economy. Injecting more dollars into the economy would stop deflation immediately, just as reducing the supply of dollars is the antidote to inflation.
    The good news is that the Fed began to dial it back in late December and made clear to investors that further deflationary rate hikes were under reconsideration. The stock market has surged in the weeks after this news.
    Which begs the question: Why did the Fed raise rates in September and December in the first place? There were almost seven million open jobs in November last year, and 2018 saw the lowest unemployment rate since the 1960s and is on track to see real economic growth of more than 3% for the first time since 2005. Average hourly pay was up. And inflation of consumer prices even before the rate hikes have been pretty flat, growing at about 1% to 2%, which is right in the sweet zone that the Fed targets.
    The Fed rate hike appears to have been a solution to a nonexistent economic problem. Analysts have defended Powell by saying that the Fed wants to prevent "overheating." Huh? Does this mean the Fed is worried that too many Americans are working or that they are earning too much money? If so, that is a very nice compliment to Trump's tax cut and deregulation policies. One thing is for sure: We never had to worry about an "overheating" economy under President Obama.
    The key point is that 3% to 4% real GDP growth, which is the achievable long-term goal of Trumponomics, is not inflationary. Let me scream it from the mountain top: Growth does not cause inflation.
    Trump has been criticized for railing against the Fed, but his argument was right. There is no inflation. And the faster growth we are aiming for can't happen if the Fed's policies are explicitly designed to restrain growth.
    Meanwhile, liberal economists are surprisingly and steadfastly defending the Fed despite the negative growth and stock market consequences. They used to fume about austerity economic policies — and they were often right. Now they are suddenly defending Fed austerity and wage-restraining monetary policies?