The Federal Reserve is using the wrong models and structural thinking to assess inflation and that’s leading the central bank to misunderstand what’s causing it, CNBC senior contributor Larry Kudlow said.
“They do not understand the monetary causes, the exchange rate causes nor the need to look at forward-looking market indicators, such as commodities. … They don’t get that,” he said in an interview with CNBC’s “Power Lunch.”
“I don’t think they have the power to move the inflation rate one way or another,” he added.
Fed Chair Janet Yellen said Tuesday that the Fed may have overstated the strength of the labor market and the rate of inflation. That may lead to monetary policy ahead that will be easier than previously thought.
In a speech delivered to the National Association for Business Economics in Cleveland, Yellen admitted that trends in employment and wage and price pressures have shifted from what central bank forecasters expected.
“More growth, more people working at better salaries and wages do not cause inflation,” Kudlow said. “What causes inflation? Excess money, which will be revealed in the foreign exchange and commodity markets and bond markets. That’s the model they should use.”
In her Tuesday speech, Yellen said a regular pace of rate hikes ahead is likely still warranted. However, she said Fed officials are looking closely at the assumptions underlying those projections.
The Federal Open Market Committee has been slowly raising rates, although it did not do so at its September meeting. It did announce it would begin to unwind its $4.5 trillion balance sheet in October. The committee also lowered expectations for inflation.
Meanwhile, Kudlow isn’t banking on Yellen staying on for another term as Fed chair, although he emphasized that was his opinion and not based on inside information. He thinks President Donald Trump wants a “reformer” heading up the central bank.
Yellen’s term as chair is up at the beginning of February.