They came, they met, they gave speeches and today are headed home from their central bankers’ conclave in Jackson Hole, Wyoming. They shared the latest reading from their models, crystal balls or chicken intestines. Leading the parade was Jerome Powell, chairman of the US Federal Reserve Board of Governors. Last year he declared that the 5.3 per cent inflation rate was “likely to prove temporary”; that there was “slack” in the labor market and “little evidence of wage increases that might threaten excessive inflation;” and that “global disinflationary forces … will continue to weigh on inflation.” He maintained negative real interest rates even as consumer inflation was rising at a rate of 8 per cent.
The chairman did not pluck these bits of unwisdom from thin air. They were based, in part at least, on the advice of the 400 Ph.D. economists on the Fed staff, pulling down salaries that average in excess of $200,000 per annum. With a fringe benefit of never having to say I’m sorry.
A Chastened Chairman
Last Friday we had a different Powell, almost grimly determined to make it clear that he is willing to force “a sustained period of below-trend-growth … [and] bring some pain to households and businesses” to reduce the rate of inflation. He did not try to use the usual excuses to divert responsibility for inflation to others. Yes, inflation is a global problem. Yes, the supply side is “constrained” and beyond the reach of Fed tools, which “work principally on aggregate demand.”
He could reasonably have added that the Fed cannot be held responsible for Germany’s decision to turn power over global energy prices to Vladimir Putin by banning fracking and closing most of its nukes while becoming dependent on Russian gas.
Biden Fuels The Fire Powell Is Trying to Extinguish
Or for President Biden’s decisions to create major fiscal headwinds for the Fed to overcome. As if the odd trillion in spending already ticketed were not enough, last week the President forgave student debt of mostly well-off students. The average student owes $25,000 to the taxpayers, about the average amount of the outstanding loan on a used car, which many likely own. Those who had ignored the President-ordered moratorium on payments, and met their obligations despite that moratorium, will be eligible for refunds.
“Reckless”, said Jason Furman, chief economic adviser to President Obama. It is “pouring roughly half trillion dollars of gasoline on the inflationary fire that is already burning.” Another well-regarded Democratic stalwart, Larry Summers, who served as treasury secretary for Bill Clinton, warns that those cancelled debts will turn into new spending, the last thing any inflation-fighter wants to see, and divert funds from programs aimed at making life better for those who did not attend college.
Instead of pointing to these policy errors as an excuse for Fed inaction, Powell accepted that “None of this diminishes the Federal Reserve’s responsibility to carry out our assigned task of achieving price stability.” Unsaid: The President might deny responsibility for the inflationary effect of his wild spending by calling soaring prices “Putin’s inflation.” The Fed’s responsibility to end the pain inflicted by run-away prices remains in place no matter what forces operate beyond its control. “Without price stability, the economy does not work for anyone.”
Signs of Success
Proving that sometimes it is better to be lucky than good, Powell rose to speak about an hour after new data on prices, income and other preinflation indicators show some easing in inflationary pressures. He undoubtedly took particular pleasure in the slight cooling of the Fed’s preferred inflation rates, which because it excludes food and energy prices is of less relevance to people who eat, drive, heat and cool their homes. He also could take comfort from a report by S&P Global Market Intelligence that business activity fell in August at the sharpest rate since early in the pandemic due to “hikes in interest rates and inflation dampened customer spending as disposable incomes were squeezed.”
And from its success in cooling the housing market.
Between June and July housing starts (-9.6 per cent), permits to build new homes (-1.3 per cent), existing home sales (-5.9 per cent), new home sales (-12.6 per cent) all fell. Only cancelations of signed contracts and house showings are increasing. “The Fed is getting what it wants,” says Matthew Walsh, an economist at Moody’s Analytics.
Lose One Get Another
The labor market is more difficult to understand. The chairman noted what every businessman with whom I speak knows: the labor market “is clearly out of balance, with demand for workers substantially exceeding the supply of available workers.” Ford, Walmart, Amazon, Best Buy, Peloton have announced lay-offs, and 50 per cent of businesses surveyed by PwC, a professional services conglomerate, foresee a reduction in headcount in the next 6-12 months. But, with two job openings for every job seeker, a lay-off is often predicate to a new and better job. Last July it took a typical unemployed worker 14.4 weeks to find a new position. This July it took only 8.5 weeks, with some workers being contacted by head-hunters on the day they were laid off.
Powell Strives For Stability and Credibility
The war for Powell’s ear is being waged on one side by those who want him to continue the 0.75 per cent increases in the Fed’s benchmark rate. On the other side are those who prefer an increase of only 0.50 per cent, or better still a pause or even a pivot to easing lest an over-zealous Fed cause a major recession.
Patrick Harker, president of the Federal Reserve Bank of Philadelphia, points out that the Fed has raised rates 86 times since 1983, and 75 of those increases were by less than 0.50 per cent. In short, either increase would be substantial by historic standards. The continued strength of the labor market will tempt the Fed to the larger increase, now, when the risk of driving unemployment to unacceptable levels is lower than it will be later in the tightening cycle.
Powell is under pressure to restore the credibility of the institution he heads. That imperative and the initial success of the Fed’s rate hikes suggests that when the policy committee meets in September it will stay the present course. Its decision, he says, will depend on “the totality of the incoming data and the evolving outlook.”
Every chairman should be entitled to build such an escape-hatch into a policy pronouncement. Especially one candid enough to admit, as he did a few months ago, “We now understand how little we understand about inflation.”