Why the Fed is often slow, late … and wrong in reading inflation

It is frequently said that the Federal Reserve steers by looking in the rearview mirror, basing monetary policy decisions on where the economy was in the past, rather than where it is today, or where it is headed.

The reason is simple: the Fed relies heavily on measures that summarize the preceding 12 months.

Those measures can be slow to reflect a sharp change in the current inflation run rate.

Consider the Consumer Price Index, which purports to measure “inflation” by tracking changes in consumer prices.

The July CPI came in at 3.4%, slightly below the June figure of 3.5% — and still far above the Fed’s 2% policy target.

It would seem that inflation must still be a serious problem, and some Fed officials are very concerned.

At the latest meeting of the Federal Open Market Committee, the Presidents of three regional Fed branches voted to increase interest rates immediately.

“The longer that high inflation persists, the more challenging and costly it can be to bring it back down,” said Beth Hammack (Cleveland).

“Pricing pressures are broadening rather than fading, and consumers are expressing despair over persistently higher prices.” Neel Kashkari (Minneapolis) worried about a risk that “high inflation could become entrenched” and projected multiple rate hikes.

Lorie Logan (Dallas) was also pessimistic.

But most Fed-watchers expect significant monetary tightening soon.

Chairman Warsh spoke of the need to continue the battle against high inflation and promised the Fed will deliver its 2% inflation target.

There’s a problem here, and it’s in the numbers.

The 3.4% CPI reading is a Year-over-Year (YoY) comparison.