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Jerome Powell’s Double Message on Inflation


For decades after its founding, in 1913, the Federal Reserve believed in opacity. Even when the agency made important policy changes, such as raising interest rates, it usually confined public statements to curt announcements, leaving longer explanations to the official records of board meetings, which weren’t released for weeks or months after the event. These days, the Fed is far more transparent. Its chair, Jerome Powell, answers reporters’ questions for about an hour after every policy meeting. (Since the pandemic began, these sessions have been conducted over Zoom.) Following the Fed’s announcement, on Wednesday, that it was raising the federal funds rate for the first time since 2018, to tackle rising inflation, some of the questions that Powell received were pointed. One of his interlocutors, Edward Lawrence, of Fox Business, pointed out that in 1981, when the Fed was confronting a big inflation spike, the federal funds rate was raised to more than nineteen per cent. Even after Wednesday’s quarter-point hike, the funds rate stands at just 0.25 per cent. Internal projections that the Fed released after Wednesday’s meeting show that Powell and his colleagues expect to raise the rate to 1.9 per cent by the end of this year, and 2.8 per cent next year—still far below the current rate of inflation, which hit 7.9 per cent in February. “Given the current data, how far behind the curve of inflation do you believe the Federal Reserve is?” Lawrence asked.

For months, critics—most prominent among them, the Harvard professor and sometime aspirant for Powell’s job, Larry Summers—have been slamming the Fed for not responding quickly enough to rising prices. The thrust of this criticism is that, by waiting too long, the Fed is more likely to have to raise interest rates to a degree that could well cause the economy to nosedive. “The next recession probably has ‘mistaken monetary policy’ written all over it,” Summers said, earlier this month. Still, Powell appeared unruffled by Lawrence’s question.“We have the tools that we need, and we are going to use them,” he responded calmly. Answering another question, he conceded that, with the benefit of hindsight, “it would have been appropriate to move earlier.” But he also emphasized that the Fed’s main policymaking body, the Federal Open Market Committee, is committed to bringing down inflation. “As I looked around that table at today’s meeting, I saw a committee that is acutely aware of the need to return the economy to price stability,” Powell said.

The Fed’s internal projections suggest that it will raise the funds rate again at each of its six remaining policy meetings this year. It is “certainly a possibility,” Powell said, that one or more of these rate hikes could be half a percentage point, rather than a quarter. By prompting a further rise in the price of oil and other commodities, the war in Ukraine will “put additional upward pressure on near-term inflation here at home,” he noted. Before the conflict began, he had expected inflation to peak in the next couple months, but now, he added, “we expect inflation to remain high through the middle of the year” before starting to decline. The projections showed that, between their meeting last December and this one, Powell and his colleagues had raised their inflation forecast for the fourth quarter of this year from 2.7 per cent to 4.1 per cent.

In a recap of the Fed meeting, the economics team at Goldman Sachs said that the central bank delivered “a consistently hawkish message,” but this review didn’t cover everything Powell said. In addition to stressing the Fed’s determination to bring down inflation, he made the reassuring argument that it can accomplish this goal without delivering any serious hit to employment and G.D.P. growth. “We do feel that the economy is very strong and well positioned to withstand tighter monetary policy,” Powell said, and the committee’s economic projections reflect this belief. They show the Fed’s preferred measure of inflation declining to 2.6 per cent in the fourth quarter of 2023, and 2.3 per cent in the fourth quarter of 2024. (The last figure is close to the Fed’s long-term inflation target of two per cent.) The unemployment rate, which fell to just 3.8 per cent last month, is predicted to fall even further in the coming months—to 3.5 per cent—and to stay at the extremely low level of 3.6 per cent in 2023 and 2024. Inflation-adjusted G.D.P. expands by 2.8 per cent this year, 2.2 per cent in 2023, and 2.0 per cent in 2024. When compared with the period from the Great Recession to the start of the pandemic, these are respectable rates of growth.

In other words, Powell’s message was mixed: resolute on rising inflation but optimistic that the costs of confronting it will be relatively small. This optimism appeared to reassure investors, who pushed the Dow up more than five hundred points on Wednesday, but it didn’t resolve some questions about the plausibility of the scenario that Powell and his colleagues presented for the economy, which is often referred to as a “soft landing.”

During previous periods of high inflation, central banks have sometimes raised interest rates so much, and so rapidly, that they caused over-all demand for goods and services to plummet, and this, in turn, prompted firms to lay off workers, sending the unemployment rate skyrocketing. (In 1982, following the aggressive rate hikes that Paul Volcker’s Fed introduced, the jobless rate reached 10.8 per cent.) With a lot more people competing for each job, downward pressure was exerted on wages and other costs, and it was this brute force that eventually brought down the inflation rate. Powell was at pains to avoid such a comparison. But, “outside of housing and autos, how do higher Fed rates reduce consumer demand unless it’s through higher unemployment?” Chris Rugaber, of the Associated Press, asked him. Powell replied that the Fed’s goal was to “better align demand and supply” by nudging down interest-sensitive demand and giving workers more time to return to the labor force after COVID. “The plan is to restore price stability while also sustaining a strong labor market,” he said. In other answers, he also emphasized that current global supply-chain problems, which have contributed greatly to the rise in inflation, should eventually recede.

Despite the added strains of the war in Ukraine, Powell is probably right about the supply chains, and there is no reason to doubt his good intentions on jobs. One of the marks of his tenure—and the tenure of his predecessor, Janet Yellen—has been a commendable effort to emphasize the Fed’s legal mandate to maximize employment, alongside its mandate to insure price stability. In the years leading up to 2020, the Yellen-Powell Fed allowed the unemployment rate to fall to levels not seen for many decades, and this created an environment in which workers, particularly low-wage workers, finally began to see their earnings rise. And, since the start of the pandemic, Powell’s Fed has emphasized the need to give the economy time to recover fully. With non-farm payrolls still about 2.1 million below their February, 2020, level, this state of full recovery hasn’t yet been reached.

Sadly, the recent surge in inflation has erased some of the wage gains that workers enjoyed. It has also raised the question of whether the Fed’s two mandates are compatible at a moment when the economy has been hit by successive supply shocks—one from the pandemic and the second from Ukraine. On Wednesday, Powell effectively argued that the two mandates are still compatible, but he also signalled that, if this doesn’t turn out to be true, the Fed will prioritize reducing inflation. Even if the full implications of this policy shift aren’t clear yet, it represents a major development.



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