How Powell at the Fed will juggle inflation and unemployment
During his first tenure as Federal Reserve chairman, when inflation seemed to be extinguished, Jerome Powell gave priority to employment. Now, however, writes the Wall Street Journal, he may have to deal with it by sacrificing jobs
During his first term, Jerome Powell became arguably the most dovish president in modern Federal Reserve (Fed) history, prioritizing full employment at a time when inflation seemed to be extinguished. In his second term he may have to do the opposite: prioritize inflation at the risk of sacrificing jobs.
The pin could be painful for both Powell and President Joe Biden. The White House on Monday praised the Fed chairman for sharing "the administration's focus on ensuring that economic growth largely benefits all workers." Yet economic conditions have changed substantially in just a year. Inflation, at 6.2%, is the highest in the last 31 years. While employment remains 4.2 million below its pre-pandemic peak, job shortages are widespread and wage growth is accelerating. All of this threatens the Fed's 2% inflation target – writes the WSJ .
For now, Powell and his colleagues, including Deputy Lael Brainard, are hoping and expecting inflation to drop as the obstacles to the pandemic recede. But the risk is growing that the assumptions that underpinned Powell's dovish turn are outdated. If so, interest rates may have to go up a lot, threatening a recession and Biden's political fortunes.
Powell, who calls himself Jay, was no one's choice for the monetary revolution. A former private equity executive and Treasury official under George HW Bush, he was named Fed governor in 2012 by then President Barack Obama, who needed a moderate Republican for partisan balance. His first instincts were a Republican hawk, expressing unease with the Fed buying bonds to keep long-term rates low.
But Powell is also open-minded. The conversation defines a fox rather than a hedgehog, a reference to the philosopher Isaiah Berlin's taxonomy of hedgehogs, guided by a single general principle, and foxes, which tap into disconnected and shifting information.
In 2018, when then-President Donald Trump made Powell president of the Fed, he got rid of his hawkish instincts. Central bank models, he said in a speech that year, were based on economic concepts that were imprecise or undetectable, a natural unemployment rate below which inflation accelerated or a neutral interest rate that balanced perfectly. unemployment and inflation. Events proved him right: unemployment has fallen steadily, reaching a level of 3.5% over the last 50 years, with no sign of worrying wage and price inflation. Indeed, inflation has persistently undershot the Fed's 2% target, prompting Powell to reverse a modest interest rate hike in 2019.
Covid last year reinforced this dovish bias as unemployment hit a post-Depression record of nearly 15% and inflation plummeted to 0.2%. The Fed cut interest rates close to zero, resumed buying bonds, and lent large sums to companies and market participants to avoid a financial crisis, efforts in which Brainard played a key part.
That summer, Powell and his colleagues revised the Fed's monetary framework. The Fed would now aim to not only bring inflation back to 2%, but a little above the target, so that over time the inflation was on average 2%. The central bank will no longer view any level of unemployment as too low, reflecting a newfound "appreciation for the benefits of a strong labor market, particularly for many in low- and middle-income communities," Powell said in a speech.
The Fed has also pledged to keep interest rates close to zero until inflation has moved above 2% and the labor market has returned to maximum employment.
Many progressives had urged Biden to replace Powell, a Republican, with Brainard, a Democrat who has been more proactive on climate and bank regulation. Trump had set a precedent, replacing Democratic economist Janet Yellen, now Biden's Treasury Secretary, with Powell as head of the Fed. But others have said Powell's commitment to full employment is more important.
But the economy today looks nothing like the one that drove the Fed's dovish change. Fearing that demand would be chronically weak as after the 2007-09 financial crisis, Powell supported Congress in spending $ 5.9 trillion in aid and stimuli. Demand is now hot, fueled by that stimulus, low interest rates, business reopening and vaccinations. Meanwhile, supply has been held back by shortages of key components and the exit of millions of workers from the workforce due to retirement, Covid and other factors. As a result, inflation has exceeded the Fed's 2% target.
Powell assumed from the previous economic recovery that the inflationary consequences of a tight labor market were exaggerated. Yet today, with an unemployment rate of 4.6%, still well above its pre-pandemic low, strong demand and labor shortages have pushed wage growth to around a 6% annual rate in the third. quarter. If sustained, this wage growth is not compatible with inflation returning to close to 2%, according to Goldman Sachs economists.
The Fed concluded from the previous recovery that "preventive" tightening – raising interest rates before inflation actually accelerates – has unnecessarily stifled job growth. The central bank therefore kept rates close to zero and increasingly negative when adjusted for inflation as the economy grew and inflation accelerated.
"While the Fed has raised rates too early in the past, this alternate timing can lead to the opposite mistake," Jason Furman, who chaired Obama's Council of Economic Advisers, said in a November 18 analysis.
Inflation is expected to decline next year as supply chains normalize and energy prices stop rising; the big question is where will it stabilize. Fed officials, and most private economists, think inflation will stabilize between 2% and 2.5%, a welcome offset to years of inflation below 2%. Markets are less optimistic: on Friday, inflation-linked stocks projected consumer price inflation at 3% through 2023, before falling to between 2% and 2.5% in subsequent years – these figures would be slightly lower using the Fed's preferred price index.
If inflation stays at 3% or above Powell would have to change his assumptions and weigh significantly higher interest rates to cool the economy. Such a strategy carries multiple risks. It could undermine equity and property values which have been supported by exceptionally low rates. As interest rates on the massive federal debt rise, the budget deficit could skyrocket. Significantly higher rates could also push unemployment, which has historically always ended up in recession. If the fear of inflation proves to be a false alarm, the Fed could inadvertently return the economy to the pre-pandemic status quo of low growth, low inflation and, ultimately, low interest rates.
Risks include political backlash, for the Fed and for Powell himself. The public hates inflation, but they won't thank the Fed for rising unemployment either.
While Trump has repeatedly lobbied Powell, Biden has vowed to respect the Fed's independence. Indeed, some analysts have warned that the appointment of Brainard would imply that inflation was not taken seriously. However, Biden has other ways of influencing monetary policy. It could fill the next three vacancies on the Fed's seven-member board with governors less aligned with Powell's priorities. Conversely, Powell could face Republican attacks if he failed to rein in price pressures.
While Powell, a lawyer by training, lacks the economic credentials of his predecessors, he makes up for it with exceptional political acumen. He has withstood Trump's pressure without alienating other Republicans, meets regularly with lawmakers from both parties, and is likely to be confirmed with broad bipartisan support. Regardless of whether Powell's reconfirmation ultimately helps Biden, the decision has bolstered the Fed's reputation for non-partisanity, a commodity in short supply these days.
(Extract from the foreign press review by eprcomunicazione )
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/come-si-destreggera-powell-alla-fed-tra-inflazione-e-occupazione/ on Sun, 05 Dec 2021 06:38:56 +0000.