Fed’s Kashkari helps aggressive fee hikes to curb ‘surge value’ inflation

In an essay published Wednesday, Minneapolis Federal Reserve Bank President Neel Kashkari admitted that he, like many of his fellow regulators and politicians, was wrong last year to insist that inflation would be “transitory.”

But he said the reason he and other policymakers were wrong was that they misunderstood the underlying causes of the recent inflation spike, which he compared to rideshare companies’ “surge pricing” adjustments that raise costs when demand goes up.

“From what I can tell, our models seem ill-equipped to handle a fundamentally different source of inflation, specifically, in this case, surge pricing inflation,” Kashkari wrote.

Neel Kashkari, president and chief executive officer of the Federal Reserve Bank of Minneapolis, said Wednesday that the Fed and the broader economics profession needs to re-evaluate how it models inflation because so many policymakers underestimated the durability of the recent inflationary cycle.

Bloomberg News

The regional Fed president also noted that a shortcoming with the Fed’s models may be that they are not calibrated to account for what he calls surge price inflation. Companies like Uber employ surge pricing to align supply with high demand in, for example, a rainstorm.  

But like a rainstorm raises demand for rides, a pandemic exacerbates demand across a variety of industries. According to Kashkari’s logic, the companies responded to high demand for products and services by raising prices for their products by more than they raised pay for their workers, resulting in record corporate profits and a subsequent decline in real wage, or labor’s share of income.

“Corporate profits climb. Income for [workers] climbs, but not as much as prices. Real wages actually fall. Even though worker incomes are up, labor’s share of income is down,” Kashkari wrote.

His essay indicates that he believes the Federal Reserve and the broader economics discipline may need to re-evaluate how it forecasts inflation going forward.

“This is a challenge for economists inside and outside the Fed: Can we develop frameworks and tools to analyze and potentially forecast inflation outside of labor market and expectations channels?” Kashkari said. “If we can deepen our analytical capabilities surrounding other sources and channels of inflation, then we might be able to incorporate whatever lessons we learn into our policy framework going forward.”

Kashkari’s comments came as the Fed published the minutes of the most recent Federal Open Market Committee meeting in December, which indicated that a number of committee members are concerned about the lagging impact of last year’s aggressive rate hikes on inflation, though most expected hikes to continue in 2023.

Kashkari, a former investment banker, Treasury official and Republican California gubernatorial candidate, also stressed the need to aggressively hike the Fed’s target rate. Though he thinks inflation may have already peaked, Kashkari indicated that the central bank may need to raise rates to 5.4% or higher before inflationary pressures subside, a significantly more aggressive projection than those of his Fed colleagues, and one that outpaces projections currently factored into the bond market.

“It will be appropriate to continue to raise rates at least at the next few meetings until we are confident inflation has peaked” Kashkari wrote.

Kashkari’s comments come as inflation continues to surge, and the consumer price index recently indicated inflation rose 7.1% year over year in November. Though down from a high of 9.1% in June, the regulator’s remarks indicate that even as rates look more hopeful than they have in a while, a vigorous debate around monetary tightening could continue for the foreseeable future.

“Given the experience of the 1970s, the mistake the FOMC must avoid is to cut rates prematurely and then have inflation flare back up again. That would be a costly error, so the move to cut rates should only be taken once we are convinced that we have truly defeated inflation,” Kashkari wrote.

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