A year ago, the Federal Reserve turned a blind eye to the gathering storm of inflation. Now the Fed is missing another big problem: A rapidly slowing economy.
In an effort to appear strong on inflation, the central bank can’t recognize that the economy is already downshifting to a slower growth rate. If it doesn’t wake up to this new threat, a job-crushing recession is inevitable.
Breaking news: Fed lifts interest rates by most in the three decades, anticipates policy rate rising to 3.8% by end of 2023
You have to worry when the Fed can’t even get the direction right when it’s describing the economy. But there it is in the very first sentence of the statement that the Fed released after the two-day policy meeting concluded on Wednesday: “Overall economic activity appears to have picked up after edging down in the first quarter.”
The economy has not been “picked up.” And the bit about the economy “edging down in the first quarter” is true only because statistics sometimes say the opposite of what they mean. You could believe it’s true only if you were fooled by the head fake in gross domestic product data in the first quarter.
The government said GDP fell at a 1.5% annual rate, but that was because the arcane arithmetic of GDP accounting treats strong domestic demand for imported goods as a sign of a weak economy. For a more realistic view of the economy’s strength in the first quarter, look at the 2.7% growth in final sales to domestic purchasers (domestic demand) or the 3.9% growth in final sales to the private sector.
Relaxing, the boom is fading. The US macroeconomics team at S&P Global IHS Markit just dropped its tracking estimate of second-quarter GDP to 0.9% after weak reports on spending services, inventory building and retail sales. Ten days ago, the estimate was 2.4%. Its estimate for domestic demand fell to 1.2% from 2.5% earlier.
The fierce headwinds of inflation are hitting consumers hard. Real retail sales plunged at an annual rate of 13.8% in May and are lower than they were a year ago. Real incomes (adjusted for inflation) have been falling for months. Real weekly wages for production workers fell at a 4.2% annual pace over the past six months.
The bloodbath on Wall Street has destroyed trillions in wealth owned by the top 20%. Similarly, the middle-class can’t count on double-digit increases in home prices anymore, thanks to a doubling of mortgage rates since the first of the year.
Investment has ground to a halt, owing to the increase in the cost of capital and the uncertainty about future demand. Business investment in structures and in equipment is falling, and investment in housing is dead. If lack of supply is the real cause of our inflationary pressures, we’d need more capital spending and more home construction, not less.
The Fed wants demand to cool a little, and, by almost every relevant measure, it’s getting its wish. I just hope they notice before it’s too late.
Rex Nutting has been writing about economics for MarketWatch for more than 25 years.
More on inflation
Inflation is now rooted in the necessities of life. Which means the Fed has little hope of lowering the cost of living without throwing millions out of work
There’s a big hole in the Fed’s theory of inflation—incomes are falling at a record 10.9% rate
Inflation, like an army of termites, has burrowed its way into the biggest item in the typical family’s budget—putting a roof over their heads. And the Fed can’t fix it.