Fed should increase rates beyond 9%, Stanford economist says

The Federal Reserve increased its key rate by 75 basis points on Wednesday. The move, intended to assist in curbing inflation, was welcomed by the markets, with S&P 500 rising 2.6 percent.

However, John Cochrane, a Senior Fellow at the Hoover Institution and a Professor of Economics at Stanford University, believes that this increase was not enough. During a video interview with Kitco News on the same day, he said that the Fed should hike the rate even higher.

For the rate to have any positive impacts, Cochrane argued that the increase needed to rise beyond nine percent. He explained to Kitco News’s anchor David Lin that in order to lower price levels, the interest rates need to be higher than the inflation rates. “With nine percent inflation, economists are talking about 10, 11, or 12 percent interest rates to bring [prices] down,” he said.

Rising prices

On July 29, The Bureau of Economic Analysis (BEA) released a report on the personal consumption expenditures (PCE) index. While disposable personal income (DPI) rose 0.7 percent, PCE rose 1.1 percent. Prices rose across various economic sectors, with prices for goods increasing 1.5 percent, prices for food increasing 1.0 percent, and prices for energy increasing 7.5 percent.

All in all, rising wages experienced by most Americans are far outpaced by the rising prices. There are also supply chain issues and the war in Ukraine which contribute to the rising inflation.

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Fed’s hiked rate

As a government institution, the Fed is susceptible to political pressure, which Cochrane believes is one of the reasons behind the low increase. Another factor is that the Fed is wary of causing a recession, a possible effect of large rate hikes.

Cochrane noted that it is possible that inflation would slow down even without intervention, a belief that seems to be shared by both the Fed and the markets. He cautioned, however, that this is contingent on there being no sudden negative worldwide developments. The war in Ukraine could become worse, a new pandemic could break out, and China could invade Taiwan - these are some examples of what Cochrane called “bad shocks” that might worsen the inflation.

Alternative solutions

Cochrane does not believe that the gold standard could control inflation. The standard was volatile.

“Every inflation was … matched by a deflation,” he said, creating an unstable economic climate. He is confident that there would be no return to the gold standard, or the Bretton Woods system which restricted trade and international capital movements in mid 20th century.

When Lin proposed a Bitcoin standard, which is also suggested by several writers, Cochrane shot the idea down. Bitcoin is “a terrible idea”, similar to gold in that it is only valuable because of its rarity, not because of its intrinsic value. It is also impractical for transactions, given the complicated and demanding computer system needed for Bitcoin.

Cochrane believes that as long as inflation remains high, there will be more rate increases in the coming future. He would also like to see the U.S. government implementing “sober” or better fiscal and monetary policies. The government should do more to manage inflation, which does not necessarily mean inventing new, unproven policies, he said.