Considering how flawed his assessment was, it will be harder for him to appear convincing when he delivers his next speech at the same venue later this month. But for the sake of the Fed’s efforts to contain inflation, it will have to try.
In his 2021 speech, Powell got several important points wrong. He claimed that an incipient rise in inflation was “probably temporary”, that the low unemployment rate “underestimates the amount of labor market slack” and that “we see few signs of wage increases that could threaten excessive inflation”. He supported the monetary policy framework more tolerant to inflation than the fed adopted in 2020 calling it “adequate to address the current challenges.”
Powell surely you want this year’s speech to be more farsighted. I hope you will emphasize three themes: that the economy still has forward momentum with an extremely tight labor market and unacceptably high inflation, that the fed should further tighten monetary policy to contain the economy and relieve pressure on the labor market, and that the fed it won’t budge until it’s sure it’s done enough for long enough to achieve its 2% inflation target.
By conveying this message, Powell it must be careful to disabuse markets of the idea that the Fed will soon finish tightening monetary policy. Many investors seem to have reached this conclusion based in part on the statement of Powell in July that future interest rate hikes will depend on economic data, ignoring his repeated reference to the Federal Open Market Committee’s rate projections indicating a peak considerably higher than financial markets expected. The result has been a rally in stocks and bonds that is undermining the efforts of the fed to combat inflation.
Powell should make it clear that even if the fed shifts toward lower interest rate hikes in the coming months, that doesn’t necessarily indicate a lower top. As the Fed closes the gap between where monetary policy was and where it needs to be, it may be able to move in a more measured way toward the same end goal.
Between 2004 and 2006, for example, the central bank raised its interest rate target from 1% to 5.25% in 17 consecutive increases of 25 basis points. The pace of adjustment had little to do with the peak in interest rates.
To convince the markets of the determination of the fed, Powell will have to be forceful. Many see his warning as mere rhetoric, designed to keep inflation expectations low. They think that once the economy slows down, unemployment rises and inflation falls, fed will start cutting interest rates long before the 2% target is reached.
Powell he will have to find a way to persuade them that he has no intention of behaving like Arthur Burns (the president of the fed prematurely gave in in the 1970s), so as not to be forced later to act as Paul Volckerwhich had to correct Burns’ mistake by leading the economy into two recessions.