Edward Lotterman
Both Sen. Hubert Humphrey and Rep. Augustus Hawkins were raised in religious families. Yet when drafting their Full Employment and Balanced Growth Act in 1977, they forgot to apply Jesus’ warning in Matthew 6 to the Federal Reserve, paraphrasing that “no central bank can fulfill two mandates.” That lapse will bedevil Fed policy makers this coming week and for several meetings thereafter.
Moreover, having ignored Israelite leader Joshua’s exhortation to “choose ye this day whom ye will serve” — whether Arthur Burns’ Keynesianism or Paul Volcker’s monetarism — the Fed’s policy-making Federal Open-Market Committee is lost.
Yes, all this is whimsical blasphemy.
But the need for coherent choices in an environment with clear benefits and dangers on both sides would be hard enough if the White House kept its prudent and traditional silence. But with Donald Trump spouting sundry threats — with clear economic impacts — on a daily basis and still campaigning to bring the Fed to his heel, that body has an unenviable task indeed.
Objectively, there are signs that output is slowing and employment stagnating. For Keynesians — who now include nearly everyone in the financial media and politics — this situation calls for increasing the money supply to lower short-term interest rates.
However, also objectively, inflation has not been tamed. Our dollar is losing value against other currencies in foreign exchange markets. That is good for farmers and manufacturers since it makes our exports cheaper, tariffs notwithstanding. It also makes imports more expensive, again independent of tariff rates du jour.
Bear with a long series of numbers demonstrating these hazards.
Wednesday’s Producer Price Index for August, which measures prices for goods and services before they reach consumers, was soothing when looked at superficially, as market pundits generally did. The index number itself was down a 20th of a percentage point from July. Compared with August 2024, it was up only 2.7%. Low and falling inflation, right?
Well, not exactly. Year-over-year comparisons are treacherous. Events months ago can mask changes right now. But it is also dangerous to just annualize the change from one month to the next. These bounce around. Looking at changes over recent ranges of months puts us on firmer ground. For the PPI, doing that for the last two, three and four months produces jarring numbers — annual rates of 4.1%, 6% and 4.8% respectively. Doing that for the last half-year, however, shows a less alarming 2.3% increase.
With any price index, it is wise to also see changes with food and energy costs stripped out. It is not that these are unimportant, but they are more volatile than other goods. Their jittery variations can hide important developments elsewhere.
Do this for the “core” PPI. Its comparison with August 2024 shows an increase of 2.9%. This isn’t alarming but neither is it down to the Fed’s announced target of 2%. Calculating annualized “core” rates for the last two, three, four and six months gives us rates of 3.3%, 3.4%, 3.5% and 3.4% respectively. So it seems a stable rate, but well above target.
Those data should raise the hair on the heads of analysts everywhere. They are a blow to assertions by Trump and his followers that inflation is dead. Indeed, since changes in producer prices are an early warning of coming price boosts at the household level, economic policy makers in the administration and at the Fed who swore oaths to do their jobs should miss some sleep.
Now look at Consumer Price index data released Thursday. These directly affect households. The year-over-year increase was 2.9%, up slightly from 2.7% in July. Again, though, the July-to-August increase converted to an annual rate is far higher at 4.7%. That should set analysts’ hair on fire rather than on end. Once again let’s look at annualized rates for the last two, three, four and six months. They are 3.3%, 3.4%, 3.5% and 3.4% respectively. No brusque acceleration but assertions of near-zero inflation clearly ring false.
Now, for one more angle, examine the “core” CPI, again stripping out food and energy costs. August 2025 is 3.1% higher than August 2024. This is being discussed everywhere. But if the July-to-August change is repeated for another 11 months, the increase would be 3.7%. The annualized rates for the last two, three, four and six months are 3%, 3%, 2.9% and 2.9%. This isn’t just “sticky” as many observers describe. It isn’t jelly on an upside-down spoon that will drip off eventually. It is cold peanut butter that may cling for a long time.
Yes, this may have been a mind-numbing barrage of percentages. But the upshot is important. Inflation may not be taking off as it did early in the Carter and Biden administrations, but neither is it falling. If anything it may be grinding slowly higher.
So the Fed is in a hard spot. There is tremendous pressure from the White House for faster money growth to push the targeted overnight interest rate lower. A meth-addicted Wall Street begs for yet another fix. Fed officials have tacitly made public promises of a target-rate cut this coming week. A new Trump minion is being confirmed to fill an open seat and he will vote.
So there will be a quarter-point cut next week. But what then? Labor force indicators are at best mediocre, although the 800,000 reduction in jobholder numbers from a normal annual benchmarking with fully complete data is overblown. Little, if any, of that can be attributed to Trump. But we certainly don’t have a rip-roaring job market, especially for young people and those with only high school degrees.
Then there is the harsh wisdom — from the Bible or elsewhere — that no person can serve two bosses and no central bank can meet two mandates given equal weight in law. Kenneth Arrow got a Nobel Prize 50 years ago for, among other work, proving that mathematically. If you have only one “policy instrument,” which for the Fed is the money supply, then you can meet only one policy objective.
That takes us back to Joshua’s warning. You have to choose one theoretical god or another. Trump apparently would have that be the labor market, which lower rates could improve; data (and perhaps Chair Jerome Powell) dictates that their master should be inflation, for which a higher or stagnant rate would serve.
Humphrey and Hawkins, writing their act in response to a request from President Jimmy Carter’s Council of Economic Advisors, assumed the core theories of John Maynard Keynes: Monetary and fiscal decision makers, that being the Fed and Congress, could face either inflation OR unemployment but would never confront both with one policy.
However, in 1977-78 when the legislation now governing the Fed was in process, our nation as well as nearly every other industrialized economy — Britain, France, West Germany and the rest of Europe — faced precisely that dilemma. Inflation was high and rising while output and employment were falling. “Stagflation,” stagnant output and employment with simultaneous acute price rises, accurately described the problem.
Economists at the University of Minnesota and Minneapolis Fed were key in identifying errors in Keynesian theory. Their theory was complex, but core policies they advocated were those of their intellectual forebear Milton Friedman. The money supply was central to economic and price stability. And money should grow steadily in step with the economy according to some rule. It must not be subject to spastic flooring the accelerator and jamming the brakes.
While the last 25 years eroded acceptance of the complex theories from this group within economics, Friedman’s prescription remains valid. Inflation worsened after Humphrey-Hawkins. Output did not improve until Volcker took over as Fed chair. He squeezed inflation out of the U.S. economy by limiting money growth even if some interest rates hit 18%. Pain was extreme, but it led to an excellent economy of stable prices, high employment and good growth of output in the 1990s. We hurled all that away in the new millennium, but that is a different story.
This stagflation specter has returned to haunt the U.S. economy, and that of the industrial world. The Fed should see that indeed it cannot meet two mandates and concentrate on the one it can fulfill. The president will rage, both caucuses in Congress will condemn and Wall Street will do deep knee bends. The process will be hard. The alternative would be worse.
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St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.
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