Jay Powell faces tough crowd in Jackson Hole after inflation mistakes
As central bankers from around the world travel to Jackson Hole, Wyoming, for the first in-person annual conference since 2019, Federal Reserve Chairman Jay Powell will be faced with something that was largely absent at the past two meetings. virtual: a difficult crowd.
Celebrated two years ago for saving the global economy and financial system from a catastrophic pandemic-induced crash, the US central bank has since faltered, initially misdiagnosing what has become inflation’s biggest problem. acute for four decades, then forced to catch up.
As a result, Powell, who was reappointed for a second term in November, is under immense pressure to perform a historically difficult task: fine-tuning monetary policy to preserve the Fed’s inflation-fighting credentials without causing more job losses than necessary.
“It’s not a great time for the Fed right now, not only because the challenges are huge, but I think the Fed has also made some missteps,” said Ellen Meade, who served as a senior adviser to the central bank board of governors. until 2021.
“Powell wants to do the right thing, and he’s not here to make a mistake,” said Meade, who is now a professor at Duke University. “But if he loses this one, it’s all ball game.”
The Fed has already embarked on the most aggressive campaign to raise interest rates since 1981 and is expected to take further action through at least the second half of 2022. Central banks in advanced and emerging economies have followed suit, grappling with their own inflationary spurts exacerbated by Russia’s invasion of Ukraine.
But former officials and economists warn that another big test of the Fed’s credibility will emerge in the next phase of tightening, when inflation has not yet slowed enough but the economy begins to show signs of weakening. more obvious weakness.
Powell, whose legacy will largely depend on the outcome, must build consensus on what is likely to become a more divided central bank.
The Fed’s predicament stems from its early assessment that the spike in consumer prices triggered by supply chain disruption and trillions of dollars in pandemic-related fiscal stimulus was temporary. It was a view shared by most, but not all, economists, and one that Powell devoted the entirety of last year’s Jackson Hole speech to supporting.
Falsified data had masked the strength of the labor market, which is now one of the tightest in history.
Viewing inflation through a “transitional” lens – a term officially abandoned by Powell in November – laid the groundwork for a series of policy mistakes that led the Fed to expand its balance sheet long after additional support n was no longer necessary. It also waited until March before raising rates.
“We should have recognized last fall that this was the time to get monetary policy back on track,” said Randy Quarles, the former Fed vice chairman in charge of oversight, who left in late 2021. “If we had responded sooner, inflation would not have reached the level it is at now.
The central bank was too committed to the idea that “you can’t hit the accelerator and the brake pedal at the same time,” Quarles said, meaning officials felt compelled to delay rising prices. rates until they stopped sucking treasuries and agency. securities backed by mortgages. Others thought the Fed should have started “scaling back” its bond purchases sooner.
Quarles, who now expects the federal funds rate to rise to 4% and a “short and shallow” recession next year, said an interest rate hike as early as November would have been appropriate.
Powell also admitted last month that the guidance the central bank provided at the end of 2020, in which it set out economic milestones to hit before it stopped easing policy, was too rigid for an environment of such uncertainty. extreme.
“I don’t think it materially changed the situation, but I have to admit I don’t think I would do that again,” he said.
Heading into this year’s Jackson Hole conference, economists say the Fed has tried to correct many of its past mistakes, after “preloading” its interest rate hikes and raising the policy rate from nearly from zero to a target range of 2.25% to 2.50% in just four months.
Most officials now expect rates to rise by at least another percentage point by the end of the year, with a third straight increase of 0.75 percentage points under consideration for the September meeting. But concerns persist about the Fed’s determination to keep squeezing the economy if unemployment climbs higher than expected. The other risk is that inflation will be much more difficult to eradicate than currently expected.
The fear is a redux of the 1970s, when the Fed oscillated between raising rates to stem price pressures and cutting them to support growth, failing to bring inflation under control in the process. The central bank then had to apply the brakes more forcefully, causing the economy to contract far worse than it otherwise would have.
“The biggest risk is that they change course too soon, not tighten too long,” said Charles Plosser, who served as Philadelphia Fed chairman from 2006 to 2015. Guns? Will they provide enough of a slowdown to actually bring inflation down, keep it low, and restore the Fed’s credibility? »
While the Fed has defined its commitment to price stability as “unconditional”, officials – unlike most Wall Street economists – argue that a recession is not inevitable.
At their latest policy meeting, they also discussed emerging signs of a cooling economy and the risks of a sharp tightening, stoking fears that a more divided Fed could give up its fight against inflation prematurely. .
On Friday, Powell is expected to stress the central bank’s commitment to doing what is necessary to fight inflation, even as she determines that it may soon be appropriate for the Fed to start implementing smaller rate hikes. .
“The Fed at this point cannot lose control of the narrative,” said Claudia Sahm, founder of Sahm Consulting and former Fed economist. “They have to make it very clear that they understand what the issues are [and] what are the potential very negative consequences of the path they have chosen.