At Jackson Hole, Federal Reserve Chairman Kevin Warsh said, “Trends matter most.” His task forces are examining how to improve monetary policy, but the next decision will test how he applies that principle today. The Fed must ground its judgment in a careful reading of the economy and explain why the evidence supports it. For families considering a home and business owners deciding whether to expand, that judgment shapes borrowing costs, investment plans, and opportunities that can last for years.
For small business owners, an improvement in financial conditions does not necessarily mean borrowing has become affordable. NFIB’s August survey put the average rate on short-term loans at 7.5%, down from 8.1% a year earlier. That is progress, but financing still carries a substantial cost. An owner weighing new equipment must judge whether the additional production and sales will justify the payments.
The latest inflation report tests that discipline. Consumer prices rose 0.4% in August, leaving annual inflation at 3.4%. Annual core inflation, which excludes food and energy, eased to 2.4% from 2.5% in July. Yet, monthly core inflation firmed to 0.3% from 0.2%. The annual improvement deserves recognition, and the monthly increase deserves criticism. Sound policy requires understanding how both can be true.
The comparisons cover different periods. An annual rate reflects a full year of price changes, while a monthly reading captures the latest movement. A lower annual rate does not necessarily mean the most recent pace is slowing. Nor does one firmer month establish that inflation is accelerating persistently. The question is whether successive reports reveal a durable change, how widely that change appears across prices, and whether other measures reinforce it.
Warsh approached that question cautiously at Jackson Hole. He said the summer readings had not persuaded him that underlying inflation had meaningfully improved and pointed to price increases remaining widespread. His concern deserves consideration. So does evidence that might challenge it. Following trends requires a willingness to revise an assessment when the facts change, even when that means departing from what policymakers previously expected.
That discipline must also extend across the measures the Fed examines. Its 2% target is measured by the personal consumption expenditures price index, or PCE, rather than the CPI. Within the PCE, services excluding energy and housing rose 0.3% in July after 0.2% in June. August data are still ahead. Those readings warrant attention, but they cannot carry the entire argument. The same standard must apply to numbers that support patience and numbers that suggest tightening.
Reading those measures together is only part of the job. Policymakers also have to understand what is producing the changes. Is demand growing faster than businesses can meet it? Are investments in equipment, technology, and workers expanding the economy’s ability to deliver goods and services? Growth alone cannot answer those questions. Stronger spending and greater productive capacity can develop together, and monetary policy must assess the balance between them.
Those decisions also shape the economy that the Fed is trying to understand. Equipment purchases can expand production. Hiring can support growth. A home purchase creates a financial commitment that lasts for decades. Policy based on an incomplete diagnosis can change which plans move forward and which are postponed, with consequences extending well beyond the next inflation report.
There are risks in both directions. Unnecessary tightening can discourage investment and hiring. Waiting too long to address persistent inflation can erode purchasing power and make restoring price stability more difficult. Because monetary policy works with delays, the Fed must assess where conditions are heading as well as where they have been. Neither automatic patience nor an automatic response to a disappointing report meets that responsibility.
THE INSIDIOUS 2% TARGET: HOW THE FED QUIETLY TAXES RETIREES AND HOMEOWNERS
When the Fed announces its decision, it should make that assessment visible. Which trends carry the most weight? Is improvement broadening or stalling? How does demand compare with the economy’s ability to produce? What evidence would change its judgment? Answering those questions would help people evaluate whether the decision follows a consistent standard. It would also leave policymakers free to respond to new information without promising a particular interest rate path.
Warsh has given the public a useful standard by which to judge the Fed. Applying it requires more than citing the latest numbers. It requires connecting the evidence to an understanding of the economy and showing why the resulting decision serves price stability and employment. Families and business owners deserve that discipline because their own decisions depend, in part, on the quality of the Fed’s judgment. Warsh said trends matter most. Now the Fed has to prove it. Getting the diagnosis wrong does not punish a statistic. It punishes real people.
Dan Varroney is an economic strategist, founder and CEO of Potomac Core, and author of Rethinking Economic Growth.
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[ H/T Washington Examiner ]
