“The Fed has already done what it needs to do to get inflation down to its 2 percent target. Interest rates are about where they need to be, which is at least a percentage point above the inflation rate. Now the Fed is in wait-and-see mode, which is more interesting than it sounds.
“We got into this inflation mess because the Fed panicked during COVID and overdid its monetary stimulus. Cooler heads have prevailed over the last two years, and now inflation is back down. The question is if the Fed will panic again at the next sign of trouble.
“GDP growth is strong, and the economy is near full employment. At some point, growth will slow down and unemployment will go up. When that happens, will the Fed go back into stimulus mode and cause inflation, or will it hold steady and keep inflation under control? That’s what markets want to know, though hopefully we won’t find out for a while.
“That uncertainty is why Fed Chair Jerome Powell’s remarks emphasize managing inflation expectations. He knows that if the Fed loses credibility as an inflation fighter, markets will simply assume high inflation will continue, and prices will continue to rise almost regardless of what the Fed does. Fiscal and monetary restraint are the only long-term cures for inflation.”