Former Treasury Secretary Larry Summers says the Federal Reserve’s job is like getting the temperature right in an old hotel shower. There is a lag between turning the faucet and the water heating up, with the result that you end up freezing or scalding yourself before you find the right temperature.

Monetary policy works with a lag of nine to 18 months, Summers says. But even though the Fed only started lifting interest rates three months ago, it’s clear that the water is already warming.

The Dow Jones Industrial Average gets the most attention, closing below 30,000 for the first time since January 2021. That is based on speculation about whether a recession is coming in the future, rather than hard indications that weakness has already set in.

But there are also signs that the situation on the ground is turning, most clearly in the housing market. Mortgage rates are flirting with 6%. Housing starts fell to the lowest in 13 months. Banks wasted no time following the Fed’s three-quarter point increase on Wednesday by lifting the prime rate—the interest rate for the most trustworthy borrowers—to 4.75%. The price of car loans and credit-card debt is going up with it.

But the only temperature that counts for the Fed is annual gain in the consumer price index, for which the most recent data in May show the highest rate of change in four decades.

The Fed’s challenge is to aim for an inflation rate 18 months into the future while only having certainty about the current circumstances from a month in the past. As it learned again this year, by the time rapid inflation turns up in the data, it is too late to do anything about it. The same is true for data about a collapsing economy.

—Brian Swint

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