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 In The Lonely Bull

The Federal Reserve has made very good progress in its fight to lower the inflation rate. In a little over a year, inflation has declined from over 9 percent to between 3 and 3.5 percent. Two percent is still the Fed’s goal. However, there are plenty of reasons to not expect a return to a rate that low.

The world is retreating from globalization. This will increase costs without the advantage from cheap foreign labor. In the wake of Russia’s invasion of Ukraine, and China’s threats against Taiwan, defense costs will need to increase in many parts of the world. Defense costs are inherently inflationary. They subtract from productivity; they do not add to it. Also, the western world’s population is getting older. This results in more social costs and diminishes productivity. A 3 percent inflation target may be the best we can expect. Long-term interest rates do not yet reflect this prospect. They will still need to climb higher.

Relentlessly pushing for the 2 percent target could result in an economy no one wants, including the Federal Reserve. It would be one with declining output, higher unemployment, and increased social costs. Remember, inflation results from too much demand for a given rate of output. Crushing demand is not the answer. Demand has been subdued; what we need now is for output to catch up. When there is plenty of everything, competition suppresses price increases. That is where we are headed if time is given a chance. That looks increasingly likely. The Federal Reserve is probably finished raising interest rates. This is what a soft landing looks like. Stay steady, my friends.

The Lonely Bull

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