How far will the Fed raise interest rates?

the producer price index, released Wednesday by the Bureau of Labor Statistics, had surprisingly high numbers. Prices charged by suppliers increased by 11.2% between March last year and March this year.

This is another sign that the Federal Reserve’s work to control inflation by raising interest rates, among other things, is just beginning. But how far should prices go to tame this beast? It’s a very complicated question.

There’s an idea out there in the monetary policy world about how to raise interest rates to beat inflation: “the so-called Taylor’s principle,” said Markus Brunnermeier, professor of economy at Princeton.

The idea, associated with US economist John Taylor, is that for every percentage point of inflation, you raise interest rates by a percentage point or more. “So if we were to apply Taylor’s principle now, I would have to raise interest rates to over 8%,” Brunnermeier said, referring to the recent consumer price index reading.

Just think of the height of 8% – how much that would increase mortgages, car loans, credit card bills and other loans. It would just be “far too traumatic,” Brunnermeier said.

The reason the Fed won’t go that far is because it’s not about your traditional, mundane inflation with mundane remedies. Energy prices, which jumped after Russia’s invasion of Ukraine, seem to be coming down. Supply chain issues are improving. Wage growth has stopped accelerating as people flock to the workforce.

“Since late October, the past five months, the US labor force has now grown at an annualized rate of 4.2%. It explodes higher,” said Jim Paulsen, chief investment strategist at Leuthold Group.

Some analysts believe that we have reached an inflation peak. Core inflation, which excludes food and energy, was weaker than expected in the CPI. Inflation will come down on its own, said Brandeis International Business School professor Stephen Cecchetti, but not completely.

“Core inflation is for sure in the 4% range, and that should be quite persistent.”

That means the Fed may have to raise interest rates to 4% or 5%. “There is no instance in the record where inflation has come down without interest rates being above inflation,” Cecchetti said.

Even if some sources of inflation disappear sooner than others, the Fed still has to fight against rising rents and food prices. He must also fight our expectations. When people and businesses anticipate inflation, they raise wage demands and prices because they expect prices to rise. After months of high inflation, our expectations have already increased.

“Michigan’s inflation expectations survey is hovering around 5%, so that’s cause for concern,” Cecchetti said. “You need to lower this. »

So one of the big things the Fed needs to change is our minds.

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