Haver Analytics
Haver Analytics

Introducing

Joseph G. Carson

Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein.   Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees.   He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.

Publications by Joseph G. Carson

  • A research paper by the staff at the Federal Reserve Bank of Dallas (1993) claims that the composite index of leading economic indicators does not provide "reliable advance information on the direction of the economy." Other studies have found that nearly half of the cyclical peak predictions in composite indexes of leading indicators were false signals.

    The key takeaway from these studies, and others, is that the forecasting record of the composite index of cyclical indicators is not 100% accurate because the group of leading indicators that accurately predicted one cycle might not work in the next. In other words, as the economy moves from one business cycle to the next, the economy changes, as does the policy structure, and some indicators become obsolete and less reliable while others gain more predictive power.

    Forty percent of the economic series that comprised the leading index in the 1980s and 1990s, when the Dallas Fed paper was researched, are no longer included. Change is a recurring feature of the leading economic indicators. In the 2000s, a new way of measuring the Treasury yield curve became part of the index. After the financial crisis of 2007-09, the redesigned leading economic index included a leading credit series and the ISM new orders series, removing broad money and vendor performance.

    It's too early to conclude confidently that the current composite index of leading indicators sends accurate or false signals. But the performance of several indicators needs to be examined to avoid a wrong prediction.

    For example, the current leading indicators index includes three new manufacturing order series. That construction is not ideal as it is best to have indicators covering a wide range of activities and sectors to avoid the intercorrelation between economic indicators.

    Also, the current economic cycle has had unique features for the goods sector. Once the economy re-opened following the closures of businesses during the pandemic, there was a record surge in demand, especially for goods, driven by pent-up demand and unprecedented fiscal and monetary stimulus. Yet, firms could only respond slowly due to part shortages and supply chain bottlenecks. That forced firms to double and even triple ordering, resulting in the most significant (record) gains for manufactured consumer goods and capital goods (excluding aircraft). Now that the "ordering binge" has ended, the new orders series have reversed, especially for consumer goods posting monthly declines in five out of the past six months. That has contributed to the leading index's monthly decreases.

    Yet, is removing "double-ordering" a sign of economic weakness or a technical adjustment in the orders series? New orders for consumer goods are off their record highs but remain elevated and stand 25% above pre-pandemic levels. Meanwhile, new orders for capital goods (ex-aircraft) were at record highs in April. It's worth noting that unfilled orders, an indicator in an earlier version of the composite index of leading indicators, stands at a record high. New and unfilled orders raise questions about whether the economy is transitioning to a slower growth environment or an outright recession.

    Another questionable component of the current leading index is the yield curve, or the spread between the yield on the 10-year Treasury and the federal funds rate. The yield curve series was included in the leading index in the mid-2000s. But that was before the Fed embarked on quantitative easing (QE) or the purchase of long-date securities with the primary intent of keeping long bond yields lower than what otherwise would be the case.

    The current inversion of the yield curve is the widest on record, negatively impacting the composite index of leading indicators. It defies logic to think that the yield curve offers similar (leading) signals when the Fed buys securities and when the Fed does not. The Fed doubled its balance sheet to over $ 8 trillion during the past three years. The yield curve was added to the composite leading index in the mid-2000s, and the Fed balance was pretty steady at $750 billion, less than one-tenth of its current size.

    With QE as a new policy tool, comparing long bond yields to inflation makes more sense as it is a proxy for real interest rates and captures the intent of QE (i.e., keeping the long-term borrowing cost low). Replacing the yield curve with a proxy for real interest rates would dramatically alter the pattern of the composite of leading indicators.

    One cannot use Paul Samuleson's comparison of the stock market in predicting "nine out of the past five recessions" with the track record of the composite index of leading indicators because if the current composition of the index does not accurately predict business cyclical turning points, it will be refitted or redesigned with a group of indicators that does. Unfortunately, that does not offer any hope for investors because people make decisions in "real-time" and can't wait for data revisions or a new index. History painfully shows that using one set of cyclical indicators to predict the future is fraught with failure. That's not a criticism of using leading indicators to help predict cyclical turning points. Still, things are constantly changing in the economy, requiring more than a small set of indicators to predict the future.

  • The budget/debt ceiling negotiation ended like several others; a lot of drama but no fundamental change. The irony is that the primary goal of these negotiations, at the least from House negotiators, was to reduce the staggering debt load of the federal government. Yet, in the end, Congress again decided to vote for more debt, a lot of it, to pay for spending.

    The Congressional Budget Office (CBO) projects that the US will run budget deficits between $1.5 to 2.0 trillion per year for the next decade, adding nearly $20 trillion to the federal government's outstanding debt.

    Nearly two decades ago, CBO projected the US would run budget deficits in the $200 to $300 billion range, which alarmed former Fed Chairman Alan Greenspan. Back then, Mr. Greenspan stated, "When you begin to do the arithmetic of what the rising debt level implied by the deficits tells you, and you add interest costs to that ever-rising debt, at ever-higher interest rates, the system becomes fiscally destabilizing," he told lawmakers. " What would he say today?

    The impact of budget deficits on interest rates varies depending on economic conditions. Yet, huge budget deficits for the foreseeable future will occur as the Federal Reserve reduces its balance sheet, removing the non-interest rate-sensitive buyer that has held down interest rates in the past several years. Market interest rates will have to go much higher to attract private sector buyers, and it would not be surprising if ten-year yields rise 100 to 200 basis points over current levels in coming years.

    To balance the federal budget requires two things; first, cutting the entitlement programs, and second, raising taxes. Critics would argue against higher taxes, but balancing the budget with tax receipts equaling less than 20%-plus % of GDP (currently running at 18%) is impossible. And since individual tax payments represent a record 50%-plus of total taxes, while corporate tax payments are near a record low of 8%, business taxes are at risk of increasing.

    In the past decade, investors have benefitted doubly from Congress's decision to use debt instead of taxes to pay for record spending and the Fed's record purchases of debt securities. Yet, that era is over. The debt deal maintains record federal borrowing, but now without the Fed as a (buying) partner. Investors should expect higher interest rates as a result. And once the higher debt costs become fiscally destabilizing, as Greenspan noted, Congress must move on taxes, with business taxes the target.

  • The wage cycle is a critical factor in the scale and length of the Fed tightening cycle. Based on the current wage data, history says the tightening cycle has yet to reach its peak rate, and the duration of the higher official rate cycle could extend much farther than the markets expect.

    The thinking behind the Fed hiking rates to break the inflation cycle is straightforward: lift rates to a prohibitive high enough level that curtails or breaks the willingness to borrow and spend. Each tightening cycle is different, and the scale and length often depend on wage and income growth.

    One traditional way to determine if higher rates are prohibitively high is to compare them to inflation. That helps determine the real borrowing costs for businesses since the price is what firms get for their products and services. Yet, to measure the real borrowing costs for consumers, one needs to compare interest rates to wages since the latter is the worker's price.

    In April, and for the first time since the Fed started to raise official rates in March 2022, the gap between Fed funds and wage growth was closed. That's the good news. The bad news is that the tightening cycles of the late 80s, 90s, and mid-2000s ended when official rates were several hundred basis points over the wage growth. So history would say the Fed tightening cycle is far from over, and the April wage and jobs data lends credence to that view.

    Still, policymakers may pause and gauge the lagged effects from the scale of the tightening to date. Lagged effects from monetary tightening are adverse and build over time. Still, the overall stance of monetary policy must be tight or restrictive for them to generate the negative economic and financial results policymakers want to achieve.

    Up to this point, the policy stance shifted from less accommodative to neutral. That helps to explain why cyclical sectors (motor vehicle sales in April were the highest in nearly two years, and housing activity has perked up) showed renewed momentum. More rate hikes will be needed to break the momentum in cyclical industries.

  • In Q1, the combined output of the cyclically sensitive motor vehicles and residential housing sectors expanded by 1.3% annualized, slightly better than the 1.1% growth for the overall economy and the first quarterly gain since late 2021. Also, the Q1 data shows that operating profits gained sequentially quarter over quarter and year over year. The rebound in cyclically sensitive sectors and profit data run counter to the recession forecasts. All economic recessions have standard features; declines in cyclically-sensitive sectors and drops in operating profits. Those features are missing at this time.

    S&P purchasing managers manufacturing index rose over one percentage point to 50.2 in April. That’s the highest level in six months, driven by new orders, production, and employment gains. Thus, the rebound in cyclically sensitive sectors has continued into Q2.

    Recessions forecasts are linked primarily to the inverted yield curve and the decline in the leading indicators. Questions over the accuracy of the signal from the inverted curve stem from the Fed's new policy tool, quantitative easing (QE). Since the Fed now actively purchases substantial quantities of long-duration fixed assets to keep a lid, or even depressing, on long-term interest rates, how can the yield curve signal be as reliable as in prior periods?

    History shows that lower long-term borrowing costs often lead to faster growth in cyclically-sensitive sectors. The yield on the 10-year Treasury has declined 75 basis points in the past six months, and cyclically sensitive sectors have rebounded. Is that a coincidence, or are they interrelated? If the latter, the recessionary signal from the inverted yield curve is wrong. It’s the latter.

    The leading economic index, which has declined sharply over the past year, triggering fears of recession, includes the yield curve. Yield curve inversion has been a significant factor in the decline of the aggregate index over the past year. Yet, is the yield curve still a reliable leading indicator with the creation of QE?

    It’s common for the index composition to change from one cycle to the next because economic, financial, or policy changes make some indicators less reliable or obsolete. Broad money failed as an indicator before the Great Financial Recession. A new credit series replaced it in 2012. It will not be surprising if the leading index includes a QE series and removes the yield curve indicator at some point.

    It’s worth noting the 2020 recession was unique from the standpoint non-economic factors triggered it. Yet, the monetary and fiscal policymakers viewed it as a vast economic disaster, rightly so, and responded with the most significant monetary and fiscal stimulus ever seen. Doubling the Fed's balance sheet from $4 trillion to over $8 trillion in 18 months was never done before, and we still need to learn all the economic and financial consequences. At the very least, the aggregate stimulus and new ways of interjecting liquidity in the system raise questions over long-trusted indicators such as the yield curve and broad money.

    Investors should keep it simple; the economy is growing if companies generate profits and hire.

  • For the week ending March 15, bank lending to commercial, industrial, real estate, and consumers increased by $40 billion, following a slight increase of $10 billion in the prior week. The two-week increase was more than half the cumulative increase over the previous two months, January and February.

    It is far too early to assess the impact of additional changes in lending standards. But the early March lending data reflects the tighter lending standards and the rise in market rates over the past year. And even with those tighter lending and higher rate conditions, the banking system showed a willingness to lend and businesses and consumers an appetite for borrowing.

    A bank-driven credit crunch may eventually happen, and investors are betting something substantial will occur, given the sharp drop in yields. But a few things may mitigate its impact, if not limit, its duration.

    First, all the top commercial banks are well-capitalized and do not face any liquidity constraints. It is hard to see a broad, deep, and enduring credit crunch that does not involve the top banks.

    Second, the Fed's Bank Lending Program should ease mid-tier banks' liquidity issues, and that should limit any pullback in credit due to tighter standards. The program runs for an entire year.

    Third, market interest rates have dropped significantly, which could boost the demand for credit.

    It is instinctive for investors to rush to buy the safest and most liquid assets, even when there is a hint of a banking crisis. That's the playbook investors have used in prior financial crises. Still, a 125 basis points drop in two-year yields over a few weeks is far bigger than during the early months of the 2007-09 financial crisis. The economic and financial data must support that negative narrative on yields for them to stay.

    History has shown that the "price" of credit has been the main rationing factor for credit. And until the "price" of credit gets more expensive through market forces or Fed raising rates, any pullback in credit should prove to be "transitory."

  • The Fed looks at bond yields as a gauge of long-term inflation expectations and its overall policy stance. Policymakers believe moderate and stable long bond yields are consistent with well-anchored inflation expectations and an appropriately configured policy stance. Yet, questions surround the current signal from long-bond rates after a decade-plus-long program of debt security purchases (quantitative easing, known as QE) by the Federal Reserve.

    Studies have shown that QE has lowered long bond yields by several hundred basis points. But, it needs to be clarified if the anchoring of long-bond interest rates via QE has also changed how the market price of long bonds adjusts to official rate hikes. Whatever the effect is, the Fed is not getting the market response it needs if it believes that higher borrowing costs are the main channel to break the inflation cycle.

    The core inflation and long bond yield picture that Fed faces today is something they have not encountered since the mid-1970s. One has to go back to the mid-1970s to find a similar alignment between long bond yields and inflation. The core inflation rate is approximately 200 basis points over the ten-year Treasuries yield, and that alignment has been in place for more than two years.

    That alignment raises several issues, all pointing to higher official rates.

    First, market rates adjusted for inflation have moved from "super" easy to still easy, indicating that the public's borrowing costs are still not sufficiently high enough to break the inflation cycle. That means the Fed has to hike official rates much more.

    Second, an inverted Treasury yield curve with market borrowing costs below the inflation rate has never occurred before. If borrowing costs matter more, as history has shown, curve inversion does not have the same adverse economic consequences. Consequently, the Fed will need to raise official rates well above market expectations creating an even greater curve inversion to get the inflation slowdown its wants.

    Third, the most significant risk to investors is if remnants of QE have permanently broken the links between long-term market borrowing rates and official rates. That would open the door to official rates moving to levels not seen in several decades. The risk of this scenario is low, but not zero, as the Fed has never faced an inflation cycle with QE in place.

  • Quantitative easing (QE) is the "albatross" of the current stance of monetary policy. Quantitative easing was a monetary tool created during the Great Financial Recession. Operating at the "zero" bound of official rates, the Fed found a new channel (QE) to provide monetary stimulus and liquidity to the economy and financial markets. QE was a new way of making money as the Fed bought bonds directly from the financial markets in exchange for cash, increasing the broad money supply.

    The first quantitative easing program ran from 2009 to 2014. During that period, the Fed's balance sheet exploded to over $4 trillion from about $500 billion before the Great Financial Recession. The Fed started the second QE program when the pandemic hit. That boosted the Fed balance sheet to $8.8 trillion, more than twice the size after the first program.

    Several studies have concluded that the first QE program was the equivalent of several hundred basis points of additional official rate cuts. The second program was as big or bigger in scale, providing monetary stimulus worth several hundred points of Fed easing.

    Since QE never existed before, no one understands how this new tool would impact the effectiveness of monetary policy when policymakers tighten policy. But it should be symmetrical. That means as long as the scale of QE remains exceptionally large (Fed balance sheet still well over $8 trillion), it will probably take much bigger hikes, and to higher levels, in official rates for the stance of monetary policy to be as restrictive as when QE was not in place. (Note: If there are no negative consequences of QE it would then go down as the greatest invention in history)

    How else can anyone explain the exceptional strength of the labor markets and historic low unemployment rate, accelerating bank lending, resilience in the equity and bond markets, and high inflation rates after nearly 500 basis points of official rate hikes, the most significant increase for a single year since the early 1980s without linking it to QE?

    Remnants of QE are preventing the Fed from accomplishing its goal of reversing the inflation cycle. Risk assets should remain well-bid as long as the Fed fails to recognize the problem. But what happens when the Fed says they were wrong again?

  • Last month, although overall headline consume prices fell 0.1%, consumer prices for services rose 0.4%. Since consumer services account for 70% of the overall price index (and 58% excluding energy services), that's the price cycle the Fed needs to crack before it can be confident that overall inflation is slowing to its 2% target.

    Breaking consumer services price cycles take time and significant increases in official rates. Since the mid-1980s, consumer services inflation cycles have reversed after the federal funds rate exceeded the inflation rate, sometimes by substantial amounts. At the end of 2022, the Fed was far from reaching the level of official rates that broke prior inflation cycles.

    That's because consumer services, excluding energy services and core consumer services less shelter, posted year-on-year increases of 7% and 7.4%, respectively, in December. So the current fed fund rate range of 4.25% to 4.5% is still 300 basis points below consumer services inflation.

    The financial markets are betting that the Fed has little more to do to reverse the inflation cycle, while history says there is much more to do. Who's right? I bet the historical pattern between inflation and the fed policy repeats itself; investors, beware.

  • The inverted Treasury yield curve has raised concern over the risk of recession in 2023, and for a good reason. An inverted yield curve has occurred before the past eight recessions. Yet, something is awry. Banks are not restricting credit as they typically would with an inverted yield curve, and businesses and consumers are borrowing at banks at the fastest rate in fifteen years. What's up?

    The thinking behind the inverted yield curve is that banks slow and eventually stop lending when bank funding costs exceed what banks can earn by lending. Yet, bank credit has been accelerating throughout 2022. The latest data for November shows bank lending to businesses, real estate, and consumers rising 11.8% over the comparable period one year earlier. That's the fastest annual growth since 2007.

    Why are banks lending so much with an inverted yield curve? Banks' total costs of funds are not determined solely by the rate of federal funds. Customer deposits account for half of the funding costs for many big banks. And with customer deposit earning (or costing) less than 70 basis points, the bank's all-in funding costs remain relatively low. So it's still profitable to lend nowadays.

    That raises questions about the recessionary signal from an inverted yield curve because, in previous periods of inverted yield curves, bank lending slowed sharply, often contracting (see chart). Can the inverted yield curve signal be trusted if bank credit is accelerating, not slowing, or contracting as in previous periods? I would think not.

    Also, why are businesses and consumers still borrowing briskly after the Fed substantially raised official rates? Because the federal funds rate is not crushingly high, at least not yet. In the past, the federal funds rate proved restrictive when its level equaled or exceeded the growth in gross income and output (see chart). In other words, to slow domestic demand, the Fed had to raise rates equal to or above the increase in gross income and output.

    At the end of the third quarter of 2022, the growth in GDP exceeded the Fed funds rate by almost 600 basis points. That's huge, indicating the economy is far from one of the conditions in place before prior recessions. Even if the Fed median forecasts of higher official rates and markedly slower nominal growth are on the mark, the GDP-Fed funds' gap will not be closed before mid-year 2023. A recession beginning around mid-year runs counter to the bullish forecasts of a strong half for 2023.

    Many believe an inversion in the market yield curve, or the spread between the yield on three-month Treasury bills and the 10-year treasury, is a robust forecasting tool due to its consistent and reliable track record. Yet, yield curve inversion, by itself, is not a sufficient condition for an economic recession. Slowing or contracting credit growth and official rate levels equal to or exceeding income growth are also necessary conditions. Those conditions are not present, so until they are, the yield-curve recession signal will remain a forecast, not a reality.

  • "It ain't over until it's over," quoting Yogi Berra, but this has been a "painless" tightening cycle for companies. According to the profit data for nonfinancial companies, profit margins (adjusted for inflation) for the first three quarters of 2022 have averaged 15.6%, essentially matching last year's figure, which was the highest in 60 years.

    In previous Fed tightening cycles aimed at slowing and reversing cyclical inflation forces, real profit margins declined, and by a lot. Declines of 200 to 500 basis points in real profit margins occurred during the tightening cycles of 1980, the 1990s, and the 2000s.

    What makes this period different? For one, the rise in official rates, while significant in scale, up 400 basis points from the start of the year, is still far below the 6.3% rate of core inflation for the twelve months ending in October. And the nominal level of federal funds at 4% is still 500 basis points below the 9.2% growth in nominal GDP for the year ending in Q3 2022.

    In short, the price increases have exceeded total unit costs for nonfinancial companies (including labor, materials, and credit borrowing). A 'pain-free" tightening cycle is not how inflation cycles end. In previous tightening cycles, companies felt the "pain" of higher interest rates, resulting in layoffs and cutbacks in spending.

    In comments at the Brookings Institution, Fed Powell said, "my colleagues and I do not want to over-tighten... that's why we're slowing down and going to try to find our way to what is the right level is". As Yogi Berra said, "You've got to be very careful if you don't know where you are going because you might not get there." Since the Fed does not know where they are going, how should investors know? Investors should expect a volatile 2023.

  • Federal Reserve policymakers are considering implementing smaller rate hikes, acknowledging the lagged effects of previous rate hikes and better news on inflation. Investors have been running with this bullish view that the apparent slowdown in core inflation, along with declines in commodity prices, changes the inflation outlook so that policymakers would scale back and possibly end their rate-hiking experiment in early 2023.

    The rally in equities has been impressive. From the low on September 30, the Dow Jones is up 20%. If the equity market follows the historical pattern between the second and third year of presidential terms, there is much more to go. The average gain in the Dow Jones average from the low in the second year to the high in the third year has been 45%. A Fed pivot could be the catalyst for additional gains into 2023.

    The risk to that optimistic scenario and sustainable equity market gains for 2023 is that the inflation slowdown could be "transitory."

    Suppose that the Fed raises official rates by 50 basis points at the December 13-14 meeting and follows that with another 50 basis points hike in early 2023. That would lift the federal funds rate to 5%. And if core inflation continues to run at 0.3% for the next five months, the twelve-month reading on core inflation in March 2023 would be 5.25%.

    What are the odds of the Fed beating the current inflation cycle and bringing core inflation back to the 2% target with nominal rates below the inflation rate? History would say the odds may not be zero, but they are low. Official rates of 300 to 500 basis points above-reported core inflation broke the inflation cycles of the 1980s and 1990s.

    Here are three reasons why the slowdown in inflation could prove to be "transitory."

    First, individuals are sitting on a cash bundle. At the end of Q2, households had $18.5 trillion in checking accounts, time deposits, and money market funds, equaling approximately 25% of total liquid financial assets, the highest share since the financial crisis. A Fed pivot could easily trigger a big risk-on rally in equity markets ("FOMO," fear of missing out, has not been retired), with spillover effects in the real economy. A rebound in equity prices, lifting consumer wealth, would boost consumer sentiment and trigger more robust consumer spending.

    Second, the Fed rate hikes have hit the housing market hard. Home sales and new construction has slowed a lot in the past year. Yet, the number of existing homes for sale at 1.2 million in October is low and well below the level before the pandemic. The cost of mortgage borrowing, currently around 6% +, might look high nowadays, but that could change quickly in a risk-on environment when people's price expectations for housing starts to rise against a very low inventory backdrop. A more robust housing market would increase demand for commodities and consumer goods, lifting prices. And it has been the recent decline in consumer goods prices that have been responsible for the slowdown in core inflation.

    Third, labor markets remain tight, with an unemployment rate of sub-4% and almost twice as many job openings as the number of unemployed. The jobless rate increased by over 200 basis points and remained relatively high for a few years following the tightening cycles of the late 1980s and 1990s. That helped sustain the slowdown in core inflation. Continued tightness in the labor markets is the biggest hurdle to achieving a sustainable slowdown in inflation as it maintains wage-cost pressures.

    Policymakers will soon face Yogi Berra's "fork in the road." Will policymakers turn left (pause) or right (continuation of rate hikes)? Investors are betting on a left turn, expecting a rally in the short run. A right turn would create more pain in the short run but offer a better path for sustainable long-term gains.

  • When policymakers started to raise official rates in the spring, the official projections showed an official peak rate of 2.8% at the end of 2023. With inflation running much faster at the time, I argued that the peak rate could be as much as 100 basis points higher than what the Fed was telegraphing. We were all wrong.

    Four consecutive seventy-five basis points increases and three hundred and seventy-five basis points in eight months look like a substantial increase in official rates. But the starting point was zero, and much more is still needed to reverse inflation risks.

    Price increases lead to revenue and profit increases for companies, while wage increases trigger income gains for workers. So when the price cycle broadens and wages increase, it takes more and more rate hikes to break the cycle because higher profits and income offsets the higher borrowing costs.

    In October, core consumer prices were up 6.7% from one year ago, while average wages for non-supervisory workers increased by 5.9%. Price increases are 260 basis points above last year's gain, while wage increases are roughly the same. At 4%, the fed funds rate is still far below the price and wage gains, so there is more ground to cover before the policy is even neutral, let alone restrictive.

    Businesses and consumers do not borrow at the fed funds rate. But the federal funds rate is the benchmark for all borrowing costs, so for market rates to be at levels that restrict borrowing, the Fed needs to lift rates to prohibitive levels. The fed funds moved above price and wage gains in the past three cyclical inflation cycles (the 1980s, 1990s, and 2000s).

    So we all were wrong. Fast and broad price and wage gains require higher official rates.