Imagine you're in a crucial job interview where the interviewer's preferences could determine your success. What would you do? Naturally, you'd try to cater to their tastes and say what they want to hear. This appears to be the exact situation facing candidates for Federal Reserve chairman positions today.
They are working overtime to prove that the 2.8% inflation rate shown in the latest Personal Consumption Expenditures (PCE) report doesn't reflect reality—even going so far as to exclude factors like rent, portfolio management fees, and tariffs to demonstrate that inflation remains essentially on target. Christopher Waller even stated, "Tariffs are not a persistent source of inflation." All this clearly aligns with Trump's dovish stance. Whether they'll continue this "performance" after taking office remains to be seen.
This selective interpretation of inflation data inevitably raises questions about objectivity. After all, one-time factors cut both ways, yet candidates seem willfully blind to this fact.
The Oil Price Paradox
West Texas Intermediate (WTI) crude prices have fallen 23% this year, creating significant downward pressure on inflation—an effect that will continue as lower energy costs work through the economy. But this situation can't last indefinitely. Examining oil company budgets reveals widespread spending cuts. At $55 per barrel, virtually no producer turns a profit. The inevitable consequence of low prices? Stimulated demand that ultimately pushes prices back up.
With global oil demand rising steadily and OPEC's spare capacity shrinking, higher oil prices appear unavoidable. When this occurs, will these same Fed candidates suddenly exclude energy costs from PCE calculations? Such hypocrisy would be glaring. Ultimately, inflation serves as the final arbiter.
The Inflation Reckoning
Our recent bout with high prices gave everyone a visceral understanding of inflation's costs. Its destructive power has toppled Western governments and eroded trust in currencies and central banks. Many still dismiss this as pandemic-related transitory effects. But if inflation resurges, the damage would grow exponentially—potentially reshaping a generation's inflation expectations.
More alarmingly, inflation continues inflating other bubbles that may take years to deflate. Traditionally the intellectual leader among central banks, the Fed now seems short on officials willing to confront inflation head-on. Compounding these challenges are the disintegration of global trade systems and AI's disruptive potential—factors whose impacts on employment, inflation and economies remain unpredictable. One certainty emerges: everyone deserves sound monetary policy they can depend on.
Unpacking the Fed's Selective Vision
Why would Fed candidates overlook oil's deflationary effects? Several deeper factors may be at play:
Political pressures: As noted earlier, candidates may downplay inflation risks and exaggerate growth potential to align with political preferences—a dynamic that threatens Fed independence and credibility.
Model overreliance: Fed economists rely heavily on complex inflation models that often miss one-off factors like oil price swings. Overdependence on these models risks ignoring real-world signals.
Lag effect neglect: Oil price impacts typically manifest with delays. If policymakers underestimate these lags, premature tightening could choke off growth.
Beyond Inflation: Oil's Ripple Effects
Cheaper oil influences more than just price indices:
Consumer spending: Lower energy bills free up household budgets, potentially boosting economic growth.
Corporate profits: Reduced energy costs improve margins, possibly encouraging hiring and investment.
Energy sector: The industry faces layoffs and reduced capital expenditures, creating regional economic headwinds.
Geopolitics: Prolonged low prices could destabilize oil-dependent nations, reshaping global power dynamics.
Navigating Complexity: The Fed's Balancing Act
In this environment, the Fed must walk a careful line:
Patience: Allow time for oil's disinflationary effects to fully materialize before reacting.
Data-dependence: Monitor comprehensive indicators—from employment to business investment—to gauge economic health.
Flexibility: Stand ready to adjust policies if growth falters, even reconsidering rate trajectories.
Transparency: Clearly communicate policy rationales to maintain public trust during uncertain times.
The Foundation of Sound Money
Amid global uncertainty, principled monetary policy becomes paramount for:
Stability: Anchoring inflation expectations while supporting growth.
Credibility: Maintaining consistency between words and actions.
Independence: Resisting political interference in technical decisions.
Adaptability: Responding nimbly to evolving economic conditions.
The Fed's selective vision regarding oil prices reveals concerning policy biases. In complex times, we need clear-eyed analysis that respects economic fundamentals—not politically convenient narratives. Without this approach, we risk repeating past mistakes and reigniting inflationary fires.
Rather than bending facts to suit political agendas, policymakers must confront reality squarely. Only through responsible stewardship can central banks preserve monetary stability—the essential foundation for sustainable economic health. This remains the Fed's true mandate and ultimate test.