In order to control inflation (CPI), the fed funds effective rate must be above CPI so that the CPI can be controlled. The current conundrum is the fed funds effective rate is way below the CPI and this means the inflation cannot be controlled by the low fed rate.
How high should the fed rate be when the US inflation was at 8.5%?
According to the calculation below, the fed rate must be above 10% to control the 8.5% inflation.
However, the FED is only projected to increase its fed rate to 2.5% by the end of 2022.
With the inclusion of the monthly sale ($95B) of the Fed assets in 2022, the fed rate is estimated to be around 3% by the end of the year and that is still below the core PCE price deflator (5.2%).
PCE: 6.6%
Core PCE: 5.2% (FED's preferred inflation indicator)
The chart below shows that the US economy has contracted by 1.4% and personal consumption has stagnated (below the median). The US economy will enter into a recessionary phase if the high inflation is not contained soon. However, any aggressive move to contain inflation will disrupt the financial market and cause a financial crisis to expedite a deep recession.
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