What a Burnt Bagel Can Teach You About the Fed & Inflation

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J.D. DURKIN: Before the midterms, you did have notable democratic senators, Elizabeth Warren comes to mind, John Hickenlooper, Sherrod Brown in Ohio. They were pretty vocal in their criticism of the Fed. Again, this is in October. This is before the midterm elections when Democrats were feeling the economic squeeze. They sensed the political potency of those inflation arguments coming from Republicans. And the argument from those Senate Democrats, Martin, at the time, was to say raising rates is all well and good, but it does nothing to address these supply side pressures of pricing. Do you expect that type of political criticism to continue from democrats? It's not something I've really heard a lot of since the midterms. Maybe I've missed it, but I wonder if that too might begin to now sound a little different now that the midterms are over.

MARTIN BACCARDAX: Imagine you have a toaster oven in your kitchen, J.D., and you've put a bagel in it in the morning, and you're looking forward to a delicious breakfast, but you've overcooked it and it starts to burn and there's smoke everywhere. Right, and the fire alarm has gone off as a result. Now, one person in your kitchen might take a tea towel and start to wave it around in order to get rid of the excess smoke. And the other person might go directly to the toaster oven and get rid of the burnt bagel. Now, you could argue that the person waving the tea towel isn't doing any good and that the more important tactic is to get rid of the bagel. But that doesn't mean that the person isn't having some kind of effect. And it would be silly for that person to just sit there and watch the smoke billow and not do anything at all.

So I think that, yes, you're probably right. The Fed's blunt instrument of interest rates aren't going to do much to affect the supply side pressures that we have seen in inflation, the toaster oven. But nonetheless, they do have that tea towel of interest rates that they can wave around and at least get rid of some of the excess smoke. And I think to a degree, that's what they have been trying to articulate. They have been sort of relatively clear that the result of the pandemic era build up in supply chain disruption, which of course increased demand for goods that simply weren't available, is a significant portion of the inflationary increase, as was energy prices and all the rest of it.

But they have also said that they still have to execute their mandate for price stability and full employment to the best of their abilities. And that is going to require some kind of demand destruction. And the only way to do that, at least at the present time, is through higher interest rates. So I can understand why lawmakers would see that as, again, waving the tea towel whilst ignoring the toaster oven. But I do accept what the Fed says in that it is better than not doing anything at all, and it really is part of their mandated task. And I don't necessarily blame them for focusing on it, even though I think most of us would understand that getting rid of the bagel was probably the most important part of the equation.