Each release of the Consumer Price Index (CPI) is greeted with great anxiety by world bond and stocks markets. That is because the Federal Reserve has repeatedly reacted to monthly CPI news by raising current and “projected” interest rates the Fed pays banks as a reward for holding reserves (IOR).
Raising the overnight rate on reserves, currently 3.15%, normally raises other interest rates though not always 10-year bond yields, which are more affected by foreign substitutes. And raising Fed policy rates usually raises the dollar.
“Inflation Report Seals Case for 0.75-Point Fed Rate Rise in November,” declared a Wall Street Journal headline about the CPI, as though it was evidently sensible for the Federal Open Market Committee (FOMC) to readjust interest rates on the basis of a one-month CPI report. On the contrary, the FOMC Statement on Longer-Run Goals and Monetary Policy Strategy points out, “Monetary policy actions tend to influence economic activity, employment, and prices with a lag.” For the Fed to increase interest rates on November 2 because a 75 bps increase September 25 failed to reduce the September CPI implies excessive impatience with lags. Some of the longest lags are built into the price indexes, particularly home rents (which as only indirectly sensitive to interest rates).
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