When Jay Powell Talks Tough, What Should We Listen To?
"My policy on cake is pro having it and pro eating it too.” - British Prime Minister Boris Johnson in a 2017 debate on Brexit.
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Is Chair Jay Powell trying to mimic Boris Johnson's policy on cake?
The US central bank chief gave a closely watched speech on Monday. It suggests he just might be trying to have it both ways.
In his prepared remarks at the National Association of Business Economics he tried to send some clear messages to investors:
Chair Powell was clearly determined to talk tough about his commitment to combating inflation.
At the same time, the head of the Federal Reserve also pushed back on the fear that, almost by definition, this commitment would inherently harm - perhaps several - US economic growth.
Powell wanted to send the message that he took inflation very seriously and was prepared to do what it takes to get it under control.
He also said, yes, we can do this.
And by "this" he really meant: yes, we can bring inflation down without harming the economy.
Here is Chair Powell on this theme using the analogy of a "soft" landing:
I hasten to add that no one expects that bringing about a soft landing will be straightforward in the current context—very little is straightforward in the current context. And monetary policy is often said to be a blunt instrument, not capable of surgical precision. My colleagues and I will do our very best to succeed in this challenging task.
What does this mean? Why care?
Two reasons:
For the first time, Chair Powell talked deliberately about possibly raising interest rates by double the standard amount (0.50% rather than 0.25%) in May.
In addressing the fear around a recession he at last acknowledged the possibility of a Fed mistake though argued that he and the rest of the Fed's Committee were up to the challenge.
In particular, he cited tightening cycles in 1965, 1984 and 1994 when the US central bank cooled an overheated economy without prompting a sharp contraction.
These points seemed expressly designed to convince the market about their credibility while also ensuring that policymakers and business leaders, could feel confident about the actual economy.
Chair Powell was saying: Wall Street should heed us and we will take great care to protect Main Street.
This all sounds nice and all but we are not buying it:
Inflation is just too high - and moving into the sticky parts of the economy, as we have discussed. Talking tough won't change this.
The labor market is also really tight. This is a bit counterintuitive but there are very few workers left to drag into the economy and help soak up those inflationary wage pressures.
The Fed is behind. Catching up is hard to do.
Lastly, many of the current inflationary issues are, as we have stated previously, supply shocks. There have been constant issues with less supply of certain key goods that are in great demand: semiconductors, houses, and now, of course, oil and natural gas as well as many key industrial metals.
It is self-obvious that raising rates aggressively will not bring more oil out of the ground or build houses any faster. They could easily harm economic growth however.
Despite his historical analogies, history is pretty clear: the longer inflation continues to rise, it is very, very probable that the Fed will err and hurt growth. Chair Powell is no fool, he likely knows this as well.
The only question is how much? And in which direction?
Will he continue to talk tough but let inflation run or will he get nervous and cause an economic downturn?
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