Inflation is always and everywhere a political phenomenon

The Federal Reserve increased interest rates yesterday for the second time since 2008 while giving forward guidance for rates possibly increasing to 1.50% by the end of 2017. This is despite inflation continuing to to come in under the Fed target of 2%. While the US is considered to be close to full employment the economy does not look even close to overheating.

The Fed faces a basic tradeoff between growth and inflation. When it cuts interest rates more cash flows into the economy and business tends to perform stronger. On the flip side when the Fed raises interest rates less money flows into the economy. That leads to slower economic growth.

The reasoning behind the increase is hard to fathom in purely economic terms. Inflation is not a threat, wages have been stagnant for sometime and it seems that average living standards are going to fall post the repeal of Obamacare and the removal from the table of minimum wage increases. Rising rates would only add to the misery of the average worker. Perhaps a different game is afoot and one that is fairly obvious. Central banks are now political players and in the face of rising populism and economic nationalism they may feel that they have to tow a political line in order to maintain independence. We have seen the UK government make specific comments querying this cherished independence and in the US Donal Trump has made no secret of how much he disdains Fed monetary policy.

Touching on a theme brought up in yesterdays post, while inflation is nowhere to be seen in a classical sense, economic nationalism, essentially a reversal of the trend of increasing globalisation with protectionist policies, is itself highly inflationary. An 'America first' policy with penalties for companies that manufacture abroad will be inflationary. The expelling of millions of undocumented migrants will remove a vast source of ultra cheap labour and is inflationary. The dismantling of Obamacare to a pure market based system will push up premiums which is inflationary. The list continues. What this represents is a paradigm shift in how we see the economy and how it will behave. Old assumptions need to reevaluated and fast.

Inflation is always and everywhere a political phenomenon