Edward Conard

Top Ten New York Times Bestselling Author

  • “…reminds us that inequality sends a signal of what society lacks most, in America’s case, entrepreneurship and risk taking.” - Lawrence Lindsey, CEO, The Lindsey Group, former Director of the National Economic Council
  • “Unintended Consequences provides a provocative interpretation of the causes of the global financial crisis and the policies needed to return to rapid growth. Whether you agree or not, this analysis is well worth reading.” - Nouriel Roubini, New York University; Chairman, Roubini Global Economics
  • “…reminds us that inequality sends a signal of what society lacks most, in America’s case, entrepreneurship and risk taking.” - Lawrence Lindsey, CEO, The Lindsey Group, former Director of the National Economic Council
  • “Unintended Consequences offers deep and well-argued analyses on almost every issue.” - The New York Times
  • “…serious thinking for serious thinkers. …a thought-provoking blueprint for growing middle- and working-class incomes.” - Mitt Romney, former Governor of Massachusetts
  • “A full-throated defense of economic dynamism.” - The Wall Street Journal
  • “…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
  • “…a very valuable contribution.” - Larry Summers, former Secretary of the Treasury and director of the National Economic Council, president emeritus, Harvard University
  • “…a must-read for serious students of economic policy.” - Glenn Hubbard, Dean, Columbia Business School, and former Chairman of the Council of Economic Advisers
  • “…a must-read for serious students of economic policy.” - Glenn Hubbard, Dean, Columbia Business School, and former Chairman of the Council of Economic Advisers
  • “…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
  • “…serious thinking for serious thinkers. …a thought-provoking blueprint for growing middle- and working-class incomes.” - Mitt Romney, former Governor of Massachusetts
Upside of Inequality Oxford Unintended Consequences

Macro Roundup


Monday, March 13, 2023

AI Summary. Very high marginal tax rates reduce incentives to work and create wealth and encourage extensive efforts to avoid or evade taxes. Estimates of the revenue-maximizing top rate run about 70%–80%, above the 37% federal maximum but closer to the roughly 50% effective rate many high earners face once state and local taxes are included.

Paul Krugman Krugman Wonks Out
Date Posted:
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.@paulkrugman argues that higher marginal taxes rates won’t be enough to close the long-run fiscal gap. “We’ll eventually have to raise taxes, at least somewhat, on people making less than $400,000.”

How much additional revenue can higher taxes on the rich raise?

Core argument: Estimates of the revenue-maximizing top tax rate tend to fall in the range of 70 to 80 percent, well above the federal maximum of 37 percent, though state and local taxes raise many high earners' effective marginal rate to roughly 50 percent.

Very high marginal tax rates create problematic incentives. Conservatives emphasize how taxes reduce the incentive to work and create wealth; this effect is surely overrated, but it does exist. More important, high tax rates encourage extraordinary efforts to avoid taxes (which is legal) or evade them (which isn’t). Estimates of the revenue-maximizing top tax rate tend to be in the range of 70 percent to 80 percent, well above the federal maximum of 37 percent — but bear in mind that many high earners also face state and local taxes that raise their effective marginal rate to something like 50 percent. So, the amount of additional revenue we can raise from taxing the rich, while substantial, is considerably less than their remaining untaxed income.

Takeaways by Macro Roundup® AI

  1. Estimates of the revenue-maximizing top tax rate tend to fall in the range of 70 to 80 percent, well above the federal maximum of 37 percent, though state and local taxes raise many high earners' effective marginal rate to roughly 50 percent.
  2. High marginal tax rates encourage extraordinary efforts at legal tax avoidance and illegal evasion, an effect more important than the reduced incentive to work and create wealth that conservatives emphasize and that is surely overrated.
  3. The additional revenue obtainable from taxing the rich, while substantial, is considerably less than their remaining untaxed income.

AI Summary. Silicon Valley Bank's failure stemmed from a duration mismatch between high-quality assets and deposit liabilities rather than the credit risk that has historically caused most bank failures. Deposits at US banks rose by $5.4tn over roughly two years, and with weak loan demand only about 15% was lent out, with the rest held in securities portfolios or cash.

Michael Cembalist J.P. Morgan
Date Posted:

A research piece by Michael Cembalist @JPMorgan calculates capital ratios for key banks assuming that all unrealized securities losses were realized. Silicon Valley Bank (SIVB) was an outlier.

Did a duration mismatch, not credit risk, cause this bank failure?

Core argument: Deposits at US banks rose by $5.4 trillion between Q4 2019 and Q1 2022, and with weak loan demand only about 15% was lent out, leaving the rest in securities portfolios or cash.

The irony of SIVB [Silicon Valley bank] is that most banks have historically failed due to credit risk issues. This is the first major one I recall where the primary issue was a duration mismatch between high quality assets and deposit liabilities. As shown below, being flooded with deposits from fast-money VC firms and other corporate accounts at a time of historically low-interest rates might have been more of a curse than a blessing. Between Q4 2019 and the first quarter of 2022, deposits at US banks rose by $5.4 trillion and due to weak loan demand, only ~15% was lent out; the rest was invested in securities portfolios or kept as cash.

Takeaways by Macro Roundup® AI

  1. Deposits at US banks rose by $5.4 trillion between Q4 2019 and Q1 2022, and with weak loan demand only about 15% was lent out, leaving the rest in securities portfolios or cash.
  2. Silicon Valley Bank's failure stemmed primarily from a duration mismatch between high-quality assets and deposit liabilities rather than the credit risk issues behind most historical bank failures.
  3. Silicon Valley Bank's flood of deposits from fast-money venture capital firms and other corporate accounts at a time of historically low interest rates may have been more of a curse than a blessing.

AI Summary. Bank system liquidity is exceptionally high but is projected to decline as higher interest rates and the Federal Reserve's balance sheet runoff withdraw over $1tn from the banking system over two years. Higher rates reduce the market value of bank securities and loan portfolios, lowering the cash banks can raise against them.

Joseph Wang Fed Guy Blog
Date Posted:

.@Fedguy12 argues “there is little risk of a crisis in the banking sector” noting “SVB was particularly poorly run” but QT is set to pull over $1T of liquidity out of the banking system, challenging bank liquidity over the next two years.

Will higher rates and balance sheet runoff drain bank liquidity?

Core argument: Quantitative tightening is set to withdraw over $1 trillion of liquidity from the banking system over the next two years, from a level of bank liquidity that is exceptionally high.

The level of liquidity in the banking system is exceptionally high but is set to steadily decline from higher rates and QT. Higher interest rates reduce the market value of bank assets, which reduces the amount of cash that a bank can raise. A secular upward swing in interest rates can potentially impose huge losses on both the securities and loan portfolios of banks. At the same time, QT is set to steadily withdraw over a trillion in liquidity out of the banking system over the next two years. This is not a problem today, but it may be in the coming years.

Takeaways by Macro Roundup® AI

  1. Quantitative tightening is set to withdraw over $1 trillion of liquidity from the banking system over the next two years, from a level of bank liquidity that is exceptionally high.
  2. Higher interest rates reduce the market value of bank assets and thereby the cash a bank can raise, and a secular upward swing in rates could impose huge losses on both securities and loan portfolios.
  3. Declining bank liquidity from higher rates and quantitative tightening is not a problem today but may become one in the coming years.

AI Summary. Raising the Federal Deposit Insurance Corporation's $250,000 coverage limit would make the government appear to guarantee a much larger share of the financial system, inviting pressure to extend protection further. The author argues the resulting larger regulatory apparatus and higher bank premiums would push lending and deposit-taking outside the formal banking system.

Tyler Cowen Marginal Revolution
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.@tylercowen speculates that the SVB resolution will likely “push additional resources outside the formal banking system altogether,” as the formal banking system now has to accommodate increased regulations and higher deposit insurance premia.

.@tylercowen speculates that the SVB resolution will likely “push additional resources outside the formal banking system...

Would raising deposit insurance limits push lending outside the banking system?

Core argument: Raising the FDIC deposit insurance limit above $250,000 would make the FDIC appear to guarantee a much larger part of the financial system, and pressures to extend protection to yet more of it would grow over time, as they did after the 2008–2009 bailouts.

Raising the FDIC protection limit from $250,000 to ??? raises political eyebrows in a dramatic manner. For one thing, the FDIC would then be seen as guaranteeing a much larger part of the financial system. Over time, the pressures for the government to protect yet additional parts of the financial system will grow, just as they did after the bailouts from the 2008-2009 financial crisis. Furthermore, if the FDIC keeps on increasing its protections in the quest for financial stability, that means a larger FDIC, a larger regulatory apparatus, perhaps higher capital requirements, and over time higher premia for banks to pay to the FDIC.  As that scenario unfolds, there will be all the more incentives to supply more lending and also deposit-taking services outside the formal and more heavily regulated banking sector. Rather than pushing more resources into the larger banks, this policy would push additional resources outside the formal banking system altogether.

Takeaways by Macro Roundup® AI

  1. Raising the FDIC deposit insurance limit above $250,000 would make the FDIC appear to guarantee a much larger part of the financial system, and pressures to extend protection to yet more of it would grow over time, as they did after the 2008–2009 bailouts.
  2. Expanded FDIC protection in the quest for financial stability implies a larger FDIC, a larger regulatory apparatus, perhaps higher capital requirements, and over time higher premia for banks to pay the FDIC.
  3. As FDIC protections and premia expand, incentives would grow to supply lending and deposit-taking services outside the formal, more heavily regulated banking sector, pushing resources out of the formal banking system rather than into larger banks.

AI Summary. Each percentage point of higher real interest rates raises US federal interest costs by roughly $250bn, given debt roughly equal to GDP, and a rate-induced recession would invite more stimulus and bailouts of the kind that fed inflation. If duration risk has spread into too-big-to-fail banks, rate increases force a choice between further bailouts and financial turmoil.

John Cochrane The Grumpy Economist
Date Posted:

.@JohnHCochrane writes, “The Silicon Valley Bank failure strikes me as a colossal failure of bank regulation,” and argues that duration risk at banks will now be an additional constraint on the Fed’s hiking cycle.

.@JohnHCochrane writes, “The Silicon Valley Bank failure strikes me as a colossal failure of bank regulation,” and argues...

Do higher interest rates force a choice between bailouts and financial turmoil?

Core argument: Each percentage point of higher real interest rates raises U.S. federal interest costs by about $250 billion, reflecting 1 percent applied to a debt-to-GDP ratio of 100 percent.

The Fed faces many headwinds in its interest rate-raising effort. For example, each point of higher real interest rates raises interest costs on the debt by about $250 billion (1 percent x 100% debt/GDP ratio). A rate rise that leads to recession will lead to more stimulus and bailout, which is what fed inflation in the first place. But now we have another. If the Fed has allowed duration risk to seep in to the too big to fail banking system, then interest rate rises will induce the hard choice between yet more bailouts and a financial storm.

Takeaways by Macro Roundup® AI

  1. Each percentage point of higher real interest rates raises U.S. federal interest costs by about $250 billion, reflecting 1 percent applied to a debt-to-GDP ratio of 100 percent.
  2. A Fed rate rise that leads to recession would bring more stimulus and bailouts, the same response that fed inflation in the first place.
  3. If the Fed has allowed duration risk to seep into the too-big-to-fail banking system, interest rate rises would force a choice between further bailouts and a financial storm.

Tuesday, March 14, 2023

AI Summary. U.S. consumer prices rose 6% year-over-year in February, down from 6.4% the prior month, according to the Labor Department. Excluding food and energy, prices rose 5.5% year-over-year versus 5.6% the prior month, though the monthly core increase picked up to 0.5% from 0.4%.

Gabriel Rubin Wall Street Journal
Date Posted:

CPI rose at the slowest rate since September 2021 in February increasing 6% y/y a decline from 6.4% in December. @WSJecon

Is inflation slowing even as monthly core price gains accelerate?

Core argument: U.S. consumer prices rose 6% in February from a year earlier, down from 6.4% in January and the slowest pace since September 2021, the Labor Department said.

The consumer-price index, a closely watched inflation gauge, rose 6% in February from a year earlier, versus a 6.4% gain the prior month, the Labor Department said Tuesday, the slowest pace since September 2021. When excluding volatile food and energy prices, consumer prices advanced 5.5% from a year earlier in February compared with 5.6% in January. Economists view so-called core prices as a better indicator of future inflation. Core prices increased by 0.5% in February compared with a 0.4% monthly gain in January.

Takeaways by Macro Roundup® AI

  1. U.S. consumer prices rose 6% in February from a year earlier, down from 6.4% in January and the slowest pace since September 2021, the Labor Department said.
  2. Core consumer prices, which exclude food and energy and which economists view as a better indicator of future inflation, rose 5.5% year over year in February versus 5.6% in January.
  3. Core prices increased 0.5% in February from the prior month, up from a 0.4% monthly gain in January.

AI Summary. US consumer price data show goods prices flat while core services prices rise strongly, with every measure of consumer price inflation down from its peak but still far too high and showing no sign of falling. The decline is attributed partly to genuinely transitory inflation and partly to Federal Reserve rate hikes that kept long-run inflation expectations anchored.

Jason Furman @jasonfurman
Date Posted:

.@jasonfurman notes that by every measure CPI inflation has peaked but CPI is “still way too high and no sign of falling…But for the banking turmoil this would have been a lock for a 50bp increase at the next mtg.”

Is consumer price inflation down from its peak but still too high?

Core argument: Jason Furman notes goods prices are flat while core services prices are rising strongly, leaving every measure of CPI inflation down from its summer peak but still way too high with no sign of falling.

The broad story remains the same: goods prices are flat, but core services are rising strongly. (Overall CPI) has come down a lot from the scary times. Economists focus less on it because it is a poor indicator of the "signal" of what future inflation will look like. Every measure of CPI inflation is down from its peak over the summer, partly because some of that inflation was truly transitory and partly because the Fed's rate hikes has kept the economy from getting much hotter and kept long-run inflation expectations anchored. That is good. But, still way too high and no sign of falling. But for the banking turmoil this would have been a lock for a 50bp increase at the next mtg. I don't recommend or expect that to happen. But I would be surprised & disappointed if the Fed pauses after 2 hot CPI reports in a row.

Takeaways by Macro Roundup® AI

  1. Jason Furman notes goods prices are flat while core services prices are rising strongly, leaving every measure of CPI inflation down from its summer peak but still way too high with no sign of falling.
  2. Furman attributes the decline in CPI inflation partly to inflation that was truly transitory and partly to the Fed's rate hikes keeping the economy from getting much hotter and long-run inflation expectations anchored.
  3. Absent the banking turmoil, Furman says the report would have been a lock for a 50bp increase at the next meeting; he neither recommends nor expects that, but would be surprised and disappointed by a pause after two hot CPI reports.

AI Summary. Uninsured domestic deposits at U.S. federally insured banks totaled $7.7tn against $10tn of insured deposits, with uninsured balances down about 9% ($780bn) while insured deposits keep rising. Because insured deposits closely match banks' outstanding loans to the real economy, the author argues banks could still lend even if all uninsured deposits shifted to money funds.

Matt Klein The Overshoot
Date Posted:

.@M_C_Klein questions the policy of unlimited deposit insurance, and suggests that the public would be better off “If instead we maintain the $250,000 deposit insurance limit and let uninsured deposits migrate to money-market funds.”

Could banks still lend to the real economy without uninsured deposits?

Core argument: Uninsured domestic deposits in the FDIC-insured banking system totaled $7.7 trillion at the end of 2022 versus $10 trillion in insured deposits, with uninsured deposits down about 9% ($780 billion) since the end of 2021 while insured deposits continued to rise.

For the FDIC-insured banking system as a whole, uninsured domestic deposits were worth $7.7 trillion at the end of 2022, while insured deposits were worth $10 trillion. Uninsured deposits have been leaving the banks since the end of 2021, down about 9% ($780 billion) whereas insured deposits continue to rise.  As it happens, insured deposits in the banking system correspond almost perfectly to banks’ outstanding loans to the real economy. If, hypothetically, all of the uninsured deposits in the U.S. left the banks and went into money funds, the banks could still do the valuable work that they ostensibly do. Moreover, the holders of those uninsured deposits would end up with safer and higher-yielding assets that do not require implicit and explicit transfers to bankers and bank shareholders. The transition could be disruptive if it happened all at once, but there is no inherent reason to fear a world where the banking sector has shrunk substantially.

Takeaways by Macro Roundup® AI

  1. Uninsured domestic deposits in the FDIC-insured banking system totaled $7.7 trillion at the end of 2022 versus $10 trillion in insured deposits, with uninsured deposits down about 9% ($780 billion) since the end of 2021 while insured deposits continued to rise.
  2. Insured deposits in the U.S. banking system correspond almost perfectly to banks' outstanding loans to the real economy, so banks could still do the work they ostensibly do even if all uninsured deposits moved into money funds.
  3. Holders of uninsured deposits that shifted into money funds would end up with safer and higher-yielding assets that do not require implicit and explicit transfers to bankers and bank shareholders, though the transition could be disruptive if it happened all at once.

AI Summary. The US approved ConocoPhillips' roughly $7bn Willow oil-drilling project in Alaska's National Petroleum Reserve, over objections from environmentalists and many Democrats. The company expects the project to produce about 180,000 barrels of oil a day at peak, equivalent to about 40% of Alaska's current crude production.

Benoît Morenne Wall Street Journal
Date Posted:

The Biden administration has given a green light to an Alaskan oil drilling project that will eventually produce 180,000bpd which is about 40% of current Alaskan output. @WSJ

The Biden administration has given a green light to an Alaskan oil drilling project that will eventually produce 180,000bpd...

Will a new Arctic drilling project boost Alaska's oil production?

Core argument: ConocoPhillips expects its roughly $7 billion Willow project in Alaska's National Petroleum Reserve to produce about 180,000 barrels of oil a day at peak, equivalent to about 40% of Alaska's current crude production.

The Biden administration approved the massive Willow oil-drilling project in the Alaskan Arctic over the objections of environmentalists and many Democrats who wanted the project scuttled. The green light means Houston-based ConocoPhillips can start construction on its roughly $7 billion project in Alaska’s National Petroleum Reserve, which the company expects will produce about 180,000 barrels of oil a day at its peak—equivalent to about 40% of Alaska’s current crude production.

Takeaways by Macro Roundup® AI

  1. ConocoPhillips expects its roughly $7 billion Willow project in Alaska's National Petroleum Reserve to produce about 180,000 barrels of oil a day at peak, equivalent to about 40% of Alaska's current crude production.
  2. The Biden administration approved the Willow oil-drilling project in the Alaskan Arctic over the objections of environmentalists and many Democrats who wanted the project scuttled.
  3. The approval allows Houston-based ConocoPhillips to begin construction on the Willow project in Alaska's National Petroleum Reserve.

AI Summary. The US, UK and Australia have unveiled a decades-long plan to supply Australia with nuclear-powered submarines, with the UK and Australia co-building a new design and each planning at least eight boats. Australia will also invest in US and UK shipyards to boost strained manufacturing capacity.

Demetri Sevastopulo and Jasmine Cameron-Chileshe Financial Times
Date Posted:

The US, Australia and the UK formally announced the Aukus agreement; in the short term American submarines will start operating out of Perth in 2027, with new submarines coming on line in the early 2040s. @FT

The US, Australia and the UK formally announced the Aukus agreement; in the short term American submarines will start...

How will allies supply Australia with nuclear-powered submarines?

Core argument: The UK and Australia each plan to build at least eight multibillion-dollar nuclear-powered submarines under the three-stage Aukus plan, with Australia and Britain co-building a new submarine.

The US, UK and Australia have unveiled a decades-long project to supply Canberra with nuclear-powered submarines, entering a historic partnership that binds the allies more tightly as they counter China in the Indo-Pacific. Under the three-stage plan, Australia and Britain will co-build a new submarine. The UK and Australia each plan to build at least eight of the multibillion-dollar submarines. The first Australian boats will not enter service until the early 2040s, with the full fleets being built over the following two decades. Australia will also invest in the US and UK’s defense industrial base, an unprecedented move aimed at boosting manufacturing capacity at strained shipyards.

Takeaways by Macro Roundup® AI

  1. The UK and Australia each plan to build at least eight multibillion-dollar nuclear-powered submarines under the three-stage Aukus plan, with Australia and Britain co-building a new submarine.
  2. The first Australian nuclear-powered submarines will not enter service until the early 2040s, with the full fleets built over the following two decades.
  3. Australia will invest in the US and UK defense industrial base, an unprecedented move aimed at boosting manufacturing capacity at strained shipyards.

AI Summary. Using satellite observations of terrestrial water storage, the authors identified 1,056 extreme drought and wet events and found their total intensity was strongly correlated with global mean temperature, more so than with El Niño Southern Oscillation or other climate indicators. They suggest continued warming will cause more frequent, severe, longer and/or larger droughts and wet extremes.

Matthew Rodell and Bailing Li Nature Water
Date Posted:

Both extreme droughts and periods of increased rainfall have increased in frequency over the 2002-2021 period. @Nature

Both extreme droughts and periods of increased rainfall have increased in frequency over the 2002-2021 period. @Nature

How closely does global temperature track the intensity of hydroclimatic extremes?

Core argument: GRACE and GRACE-FO satellite observations of terrestrial water storage delineated 1,056 extreme droughts and pluvials during 2002–2021, with an ongoing pluvial that began in 2019 and engulfed central Africa dwarfing all other events.

Distortion of the water cycle, particularly of its extremes (droughts and pluvials), will be among the most conspicuous consequences of climate change. Here we applied a novel approach with terrestrial water storage observations from the GRACE and GRACE-FO satellites to delineate and characterize 1,056 extreme events during 2002–2021. Dwarfing all other events was an ongoing pluvial that began in 2019 and engulfed central Africa. Total intensity of extreme events was strongly correlated with global mean temperature, more so than with the El Niño Southern Oscillation or other climate indicators, suggesting that continued warming of the planet will cause more frequent, more severe, longer and/or larger droughts and pluvials. In three regions, including a vast swath extending from southern Europe to south-western China, the ratio of wet to dry extreme events decreased substantially over the study period, while the opposite was true in two regions, including sub-Saharan Africa from 5° N to 20° N.

Takeaways by Macro Roundup® AI

  1. GRACE and GRACE-FO satellite observations of terrestrial water storage delineated 1,056 extreme droughts and pluvials during 2002–2021, with an ongoing pluvial that began in 2019 and engulfed central Africa dwarfing all other events.
  2. Total intensity of extreme events correlated more strongly with global mean temperature than with the El Niño Southern Oscillation or other climate indicators, suggesting continued warming will cause more frequent, more severe, longer and/or larger droughts and pluvials.
  3. The ratio of wet to dry extreme events decreased substantially in three regions, including a vast swath from southern Europe to south-western China, while increasing in two regions, including sub-Saharan Africa from 5° N to 20° N.

AI Summary. U.S. consumer prices rose 6% year-over-year, down from 6.4% the prior month, while core prices excluding food and energy rose 5.5% versus 5.6%, with monthly core prices up 0.5% led by a 0.8% rise in shelter costs. The Federal Reserve faces balancing interest rate increases against banking sector instability.

Gabriel Rubin Wall Street Journal
Date Posted:
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U.S. inflation cooled in February with CPI rising 6% YoY, down from 6.4% in January. Core prices increased 5.5% YoY, driven by a 0.8% increase in shelter costs.

Is inflation cooling even as banking instability complicates rate decisions?

Core argument: U.S. CPI rose 6% year-over-year in February 2023, down from 6.4% in January and the slowest pace since September 2021, though still above the pre-pandemic rate of just over 2%.

In February 2023, U.S. inflation showed signs of cooling, with the Consumer Price Index (CPI) rising 6% year-over-year, down from 6.4% in January, marking the slowest pace since September 2021. Core prices, excluding food and energy, increased by 5.5% compared to 5.6% in January, indicating persistent price pressures. Monthly data revealed a 0.5% rise in core prices, the largest in five months, driven by a 0.8% increase in shelter costs. Despite easing inflation, the Federal Reserve faces challenges balancing interest rate hikes to control inflation while addressing banking sector instability following the collapse of Silicon Valley Bank. Investors anticipate a 25 basis point rate increase at the Fed's upcoming meeting, with a focus on maintaining financial stability. The Fed's actions are crucial as inflation remains above the pre-pandemic rate of just over 2%, impacting consumer behavior and economic dynamics.

Takeaways by Macro Roundup® AI

  1. U.S. CPI rose 6% year-over-year in February 2023, down from 6.4% in January and the slowest pace since September 2021, though still above the pre-pandemic rate of just over 2%.
  2. Core prices excluding food and energy rose 5.5% year-over-year, versus 5.6% in January, while monthly core prices increased 0.5%, the largest gain in five months, driven by a 0.8% rise in shelter costs.
  3. Investors anticipate a 25 basis point rate increase at the Federal Reserve's upcoming meeting as the Fed balances controlling inflation against banking sector instability following the collapse of Silicon Valley Bank.

CPI rose at the slowest rate since September 2021 in February increasing 6% y/y a decline from 6.4% in December.

“…The consumer-price index, a closely watched inflation gauge, rose 6% in February from a year earlier, versus a 6.4% gain the prior month, the Labor Department said Tuesday, the slowest pace since September 2021. When excluding volatile food and energy prices, consumer prices advanced 5.5% from a year earlier in February compared with 5.6% in January. Economists view so-called core prices as a better indicator of future inflation. Core prices increased by 0.5% in February compared with a 0.4% monthly gain in January…”

Gabriel Rubin and Nick Timiraos, "U.S. Inflation Cooled in February as Fed Confronts Bank Failures,"Wall Street Journal, March 14, 2023, https://www.wsj.com/articles/inflation-report-arrives-as-fed-confronts-bank-failures-5f0e10ae

U.S. Inflation Cooled in February as Fed Confronts Bank Failures

Inflation eased in February but remained stubbornly high, presenting a challenge for the Federal Reserve as it confronts how to slow the economy with higher interest rates at the same time it moves to stem banking problems.

The consumer-price index, a closely watched inflation gauge, rose 6% in February from a year earlier, down from a 6.4% gain the prior month, the Labor Department said. It was the smallest increase since September 2021. When excluding volatile food and energy costs, prices advanced a slightly slower 5.5%. Economists view so-called core prices as a better indicator of future inflation.

Monthly data showed price pressures persisted in many corners of the economy. Core prices increased by a seasonally adjusted 0.5% in February, the largest monthly gain in five months. Shelter costs rose 0.8% over the month, matching the largest monthly gain since the 1980s.

Economists said Tuesday’s consumer-price index report underscored the urgency of the Fed’s inflation fight. Several said they thought it made officials more likely to raise rates next week by a quarter percentage point as long as the banking sector didn’t appear to come under additional stress ahead of its rate decision.

The Fed’s March 21-22 meeting could feature an intense debate over the benefits of holding rates unchanged to provide more time to see if the banking crisis eases versus continuing to raise rates to avoid creating new confusion over the central bank’s approach to controlling inflation.

U.S. Inflation Cooled in February as Fed Confronts Bank Failures: Extended Excerpt Image 1


Prices for airfare and lodging also rose in February. Gasoline and food prices both increased last month, but at a slower pace than in January. Consumers paid less last month to heat their homes, and prices for medical services and used cars also fell.

Elevated inflation, combined with a strong labor market and solid consumer spending, appeared to put the Fed in a position to consider a larger interest-rate increase at its next meeting. But the collapse of Silicon Valley Bank and other financial institutions could lead the central bank to move more cautiously to assess the state of the financial system.

Investors in interest-rate futures markets on Tuesday placed a roughly 85% probability of a quarter-point increase at next week’s meeting, compared with a 15% chance of no increase, according to CME Group.

“The Fed still has more work to do” to bring inflation back to near its 2% target, said Michael Gapen, chief U.S. economist for Bank of America. “If the Fed is successful at corralling the recent market volatility and ringfencing the traditional banking sector, then it should be able to continue its gradual pace of rate hikes until monetary policy is sufficiently restrictive.”

U.S. Inflation Cooled in February as Fed Confronts Bank Failures: Extended Excerpt Image 2


Other economists said February consumer inflation figures were more likely to extend the Fed’s rate increase cycle later into the summer, with officials foregoing an increase next week.

“We think Fed officials will be reluctant to take the risk that monetary policy actions could work at cross-purposes with financial stability policy by worsening banks’ balance sheet problems and undermining confidence,” said Jan Hatzius, chief economist at Goldman Sachs.

The bank expects the Fed to raise interest rates to around 5.4% this year, resuming rate increases after holding steady next week.

Fed officials slowed their pace of rate increases last month when they increased their benchmark rate by a quarter-percentage-point to a range between 4.5% and 4.75%. Sharply higher interest rates exacerbated problematic risk-taking decisions at the $110 billion Signature Bank and $209 billion Silicon Valley Bank, which were taken over by government regulators.

U.S. Inflation Cooled in February as Fed Confronts Bank Failures: Extended Excerpt Image 3


Hot core inflation—prices rose 5.2% over the last three months at an annualized rate—has run well above economists’ expectations and further highlights the tension between the Fed’s financial-stability and price-stability goals. That could force markets “to reconsider what we see as an ill-founded view that the SVB crisis means the Fed is likely done raising rates,” said Krishna Guha, vice chairman of Evercore ISI.

Before the bank failures, the broader economy showed surprising strength to start the year. Spending at retailers and restaurants rose in January at the fastest monthly rate in nearly two years, and employers added more than 800,000 jobs during the first two months of the year.

At First Watch Restaurants, Inc., a chain of more than 400 breakfast and lunch cafes, there has been little sign of a consumer pullback. While labor and related costs rose by 11.4% in 2022, the company raised menu prices by an average of 7.8% during the year, after being able to keep prices flat during 2021. Annual supplier contracts have helped keep the chain’s food costs predictable, while same-restaurant sales rose 14.5% compared with 2021.

To capitalize on eager customers, the company is working to keep wait times low during peak periods such as weekend mornings. It is experimenting with different kitchen configurations and specialized roles such as dedicated beverage runners to free up servers.

“We have unfulfilled demand that’s right at our front door,” First Watch Chief Executive Chris Tomasso said. “We’re investing in improvement and processes and equipment and things such as that to capture that demand.”

Still, some signs of cooling have emerged. Economists estimate that retail spending declined in February. The Commerce Department will release new consumer data on Wednesday.

Wage growth moderated last month, suggesting that tight labor markets aren’t leading to rapid increases in workers’ paychecks. And job openings, while still well exceeding the number of unemployed seeking work, fell in January, the Labor Department said. Private-sector job postings estimates show continued cooling demand for labor.

While consumer inflation is down from its recent peak last June, it is still well elevated from a prepandemic rate of just over 2%. High prices have caused some consumers to pull back and seek cheaper alternatives.

Ruby Koch-Fienberg and Ben Surface, of Dover, N.Y., shopped around for a contractor who would replace a malfunctioning wood-burning stove and demolish its damaged chimney. They were told that there was little chance the work could be completed this winter, given the backlogs of work, and the job could cost thousands of dollars.

They are now contemplating doing the chimney demolition themselves.

“We could save up to $8,000 and have a really fun weekend,” Ms. Koch-Fienberg said.