While I am not an economist like my colleague and fellow Augusta Business Daily contributor, Dr. Simon Medcalfe, many of my family, friends, and acquaintances assume that because I am a business school faculty member and former Dean, that I am an expert on the economy.
Therefore, many of them come to me with their questions related to the economy, particularly in times like these when we are getting many mixed signals and we are not sure what is good news or bad news economically anymore. For instance, in the past, we usually considered strong employment reports unequivocally good news. However, now, it seems like such news does not always have positive impacts on our financial markets, in particular, our equity and bond markets.
Since I do have a strong foundational knowledge of economics and stay well informed by reading and listening to those whom I consider experts based on their track records, I am happy to share my thoughts and insights with those who ask. I have received a number of recurring questions in recent weeks and months and I thought it might be helpful to share those questions that came in my “mailbag” and my answers to them. So, with the caveat that I am not an economist, here we go with the types of questions I have been receiving.
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We keep hearing that inflation is going down and other economic data is pointing in a positive direction. Why then do things still feel so bad for the average consumer?
Yes, the rate of inflation is coming down and that is a good thing. Inflation was very low (most well below 2% annually) from 2012 to 2020, but rose to 6 to 8% annual rates in 2021 and 2022. While the annual rate of inflation came down to 3.4% for 2023 and has continued to decrease early in 2024, it still remains above 3%. Unfortunately, some people are under the impression that the rate of inflation coming down means that prices will come down.
As we all know, that is not true.
Rather, the lower inflation rates merely means that the increase in prices is less than it was in 2021 and 2022.
Prices are up more than 15-20% from three years ago, whereas for the decade before that, prices averaged increasing around 5% over most three-year periods. So, the average consumer is still feeling the pain as each individual’s spending power has been seriously eroded. So, despite good news on the decreasing rate of inflation, increasing number of jobs, and higher Gross Domestic Product (a sign of a growing economy), most people feel much worse off than they did three years ago.
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Why does the Federal Reserve (Fed) have to wait for the annual inflation rate to reach 2% before lowering interest rates? Isn’t 3% low enough? Isn’t it true that higher interest rates hurt consumers more than higher inflation?
There are a number of reasons why the Fed needs to wait to lower rates. Primarily, higher interest rates are the Fed’s most effective tool for lowering inflation. If it moves too soon to lower rates and inflation is not under control, it would have to quickly reverse course and raise rates again. Such instability in rates would start to wreak havoc in financial markets. A rate of inflation of 2% is the Fed’s target in order to limit the erosion of spending power, while keeping employment levels appropriate. Not only does a 3% rate of inflation erode spending power by 50% more than 2% on an annual basis, but the compounding effect of consecutive years of 3% inflation erodes spending power even further. Inflation has a much more damaging effect on lower and middle-income consumers than higher interest rates, so getting inflation under control is much more of a priority.
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When do you think rates will start coming down? Is this impacted by the election in general and the presidential election in particular?
Until the Fed’s meeting last week, many investors believed that the Fed would begin lowering rates at its March meeting.
After listening to Fed Chair Jerome Powell and reading the notes from the Fed’s meeting, almost all investors are not expecting a rate decrease in March. Most believe that rates will start coming down after the Fed’s May meeting.
If you remember my prediction in my December 13 column, I indicated rates would not begin to decrease until the fourth quarter of 2024, after the election. However, based on the current data and after listening to Chair Powell’s comments on 60 Minutes this past Sunday, I am thinking the first interest rate decrease will happen sometime in the third quarter (July to September).
There are those who believe earlier interest rate cuts favor President Biden and the Democratic Party for the upcoming election, which is probably true. However, I believe Chairman Powell and the Fed when he says their decisions will be driven by data. When asked on 60 Minutes if politics or elections factor into the Fed’s decisions, he said: “We never do. And we never will. Integrity is priceless, and in the end, that’s all you have.” I take Chairman Powell at his word and trust he will do what is best for our country and its economy.
While I am not an economist, I hope that this column provided you with some insight into our economy and what we might expect in the coming year.
