"The real danger comes from [the Fed] encouraging or inadvertently tolerating rising inflation and its close cousin of extreme speculation and risk taking, in effect standing by while bubbles and excesses threaten financial markets."
- Paul Volcker
Volcker warned about the two cousins of inflation - asset and price inflation. We got the asset inflation over the last decade, but we had to wait for the price inflation after the pandemic. The asset inflation is easy to identify and control. Equities gained from strong earnings and increasing valuations. Price inflation is more complex to identify. There can be supply shocks which create relative price distortions and there can be feedback from price gains to wage increases.
The Fed is doing its job to arrest the stock market. Increasing discount rates reduces the present value of earnings and reduce the value of projects. We are in a bear market that reverses asset inflation. The price inflation has yet to be reversed. Increasing rates will reduce aggregate demand, but it is a blunt instrument. A tightening policy can reduce overall demand, but it cannot reverse gasoline prices or food prices. Weaker demand will reduce wage pressure, but it will not create new jobs.
The Fed cannot just reduce asset or price inflation. These inflation cousins are joined together. When one goes down, the other will follow it.
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