In Fed we trust
The least democratic institution in the government is the only one trying to bring down inflation. That's far too risky. Congress and White House must do more.
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Six men and five women, all unelected, voted yesterday on a policy that will affect nearly everyone, determining in part whether you can afford to buy a home or a car; pay your credit cards; or even if you still have a job this time next year.
What could possibly go wrong? A lot.
All but one of the eleven members voted to raise the federal funds rate by 3/4 percentage point. That’s the largest increase since 1994. It will push up the interest rates that consumers and businesses must pay. The Fed is making it costlier to borrow and spend. The increase is also somewhat larger than the increase that financial markets expected before an article in the Wall Street Journal came out on Monday.
The Fed is trying to thread the needle of lowering inflation without causing a recession
The Fed’s decision to push up interest rates is intended to bring inflation down. Inflation is too high, and the Fed is using the one tool it has to bring it down. In the press conference, Fed Chair Jay Powell explained the Fed’s thinking.
This presser was a little bumpy, but I give Powell a lot of credit on balance. Explaining monetary policy without sounding callous is incredibly hard, albeit doable. And that challenge is on top of making these incredibly hard decisions. Every single person at the Fed knows that these decisions could be the line between recession or not. Every single person there is sick over the high inflation.
The Fed knows and has admitted publicly that it made some mistakes in the past year. Even so, they stand back up and keep going. The Fed is trying to do something—bring down high inflation without pushing us into a recession—that no Fed has done successfully. And its tools come with some pain, as I explained in my post last week:
Why is less wage growth a “good thing” [to the Fed], even when inflation is high? The story goes like this: the Fed’s job is to get inflation down, which is high due to demand exceeding supply. The only thing the Fed can do is help lower demand. The Fed can’t tell people to spend less, but it knows income, including wages, is a crucial determinant of how much people spend. Even more so than interest rates, which it is raising “expeditiously.” Indirectly, the Fed has some effects on income but so does a long list of factors. So, it cheers on moderation in wages, hoping inflation moderates with it.
It’s a delicate balance, and it’s easy to see why some believe that the Fed will have to slam on the breaks to get inflation down and cause a recession. High enough interest rates will get people’s attention. But that would be more than “tempering” demand.
I have sympathy for the Fed. It is very limited in its tools. If I had a crystal ball and a magic wand for the economy, I would give them to Jay. I don’t. No one does.
The Fed is doing what it can. And to avoid a recession, we must also have some things in the world go our way. After two and half years of rolling, not-seen-in-generations crises, we deserve it. But we cannot count on them. This time last year, the Fed thought that Covid was getting under control. Monthly inflation stepped down for several months. That’s why it said “transitory.” Then came delta, then Omicron, and then lockdowns in China. And on top of the pandemic, we have a war in Europe involving two of the world's largest commodity producers. So yeah, whiffing on transitory inflation ain’t the worst of it. Even so, high inflation is a problem to solve.
We have inflation because of more demand than supply. It is inane to argue about how many basis points of inflation belong to which policy mistake. The house is on fire; stop arguing outside. We can argue for years to come. Help put out the fire now.
The Fed has tools to cool off demand and that’s what it is doing. Yesterday they decided to raise interest rates again and this time by more.
It’s not all sunshine and roses at the Fed
Even if I mostly agree with the Fed’s policy now. It remains very problematic that individuals who are not accountable to the American people have so much power. That’s how Congress set the Fed up over a hundred years ago, so this problem is not new. Even so, it keeps coming up.
Repeatedly, the Fed has broken our trust. I am not talking about forward guidance. I am talking about ethics. This week was another needless fiasco and comes on the heels of an alleged trading scandal involving two Reserve Bank Presidents and the Vice Chair last year. After that, Powell promised then that the Fed would work harder to avoid even appearances of unethical behavior. So how’s that going?
Not well enough. The Wall Street Journal broke a story on Monday—which looked a lot like a leak, even if it was not—that the Fed would do a larger-than-expected rate increase in two days. And the Fed did nothing to clean it up after the article ran.
If Fed officials passed this information to the WSJ, it would have violated the communication policy for Fed officials. Here’s a relevant section:
7. To facilitate the effectiveness of the Committee’s policy deliberations and the clarity of its communications, participants will observe a blackout period on monetary policy communications in conjunction with each regularly scheduled Committee meeting. The blackout period will begin at the start of the second Saturday (midnight) Eastern Time before the beginning of the meeting and will end at midnight Eastern Time on the next day after the meeting. For example, if the Committee meeting starts on a Tuesday, the blackout period will begin at the start of the Saturday that falls ten days earlier, and if the meeting ends on a Wednesday, the blackout period will end at the end of Thursday. During each blackout period, participants refrain from expressing their views about macroeconomic developments or monetary policy issues in meetings or conversations with members of the public.
The very first question Powell got at the press conference was about the possible leak:
HOWARD SCHNEIDER. Thank you, Howard Schneider with Reuters. Two related questions, Chair Powell, did you feel you boxed yourself in with the language you used at the last press conference on 50 basis point hikes in June and July and would you please give us, as detailed a sense that you can, of what role you played in reshaping market expectations so quickly on Monday.
CHAIR POWELL. So, as you know, we always aim to provide as much clarity as we can about our policy intentions subject to the inherent uncertainty in the economic outlook, because we think monetary policy is more effective when market participants understand how policy will evolve, when they understand our objective function, our reaction function. And in the current, highly unusual circumstances with inflation well above our goal, we think it's helpful to provide even more clarity than usual, again subject to uncertainty in the outlook. So, and I think over the course of this year financial markets have responded and have generally shown that they understand the path we're laying out. Of course it remains data dependent, and so that's what we generally think about guidance and that's why we offer it. And of course, when we offered that, when I offered that guidance at the last meeting, I did say that it was subject to the economy performing about in line with expectations. I also said that if the economy performed, if data came in worse than expected, then we would consider moving even more aggressively. So, we got the CPI data and also some data on inflation expectations late last week, and we thought for a while and we thought well this is the appropriate thing to do. So, then the question is, what do you do? And do you wait six weeks to do it at the next meeting? And I think the answer is that's not where we are with this. So, we decided we needed to go ahead and so we did. And that's really the, that's really how we made the decision.
That was a good answer to the first question, though I would not hang the extra 25 basis points on the inflation expectations data. That was $5 gas. But CPI was legit bad, and while I disagreed with the move, I can see its logic.
Powell dodging the second question was bad. A simple, “No, there was no external communication in the blackout would have cleared it up.” And he must have been prepped on it. Communications are tough. But it’s essential, especially when having so much power, not to even look unethical. This would not have happened if the Fed cared half as much about the public trust as it does about inflation expectations and financial market traders. It’s the American people the Fed serves. Full stop.
Congress and the White House must get in the game
The immediate economic problem is that inflation is too high. Regardless of what you think of the Fed, we should all be able to agree that Congress and the White House must do more on inflation. They are elected officials. And it’s obvious that people—across the political spectrum—want inflation down, especially prices at the pump and in the grocery store. The Fed CANNOT get food and energy prices down with its tools without a recession. We need more supply. No one wants a recession.
People’s lives and livelihoods depend on good policy.
I made this sign on June 5, 2020, after the employment report came out. And I went downtown. Here is outside the Old Executive Office Building next to the White House. I carried it in the Black Lives Matter protest of George Floyd’s murder.
The Black unemployment rate is now 6.2%. That is a massive improvement. It matters. The national unemployment rate is 3.6%, close to its fifty-year low. Yes, inflation is a hardship. No paycheck is a disaster. The recovery is halfway done but halfway is a feat, especially when compared to the start of the pandemic.
If Congress and the White House do nothing and force the Fed to go it alone in bringing inflation down, they are risking a recession. They are risking people losing their jobs again. They are risking a lot of hardship.
Congress and the White House must move heaven and earth to get gas prices down and avoid a global humanitarian crisis of starvation. Get supply up! The Fed cannot print oil or wheat. Do more. Many are and have good ideas, for example:
Now is an excellent time to pass long-term energy legislation, including responsible production of fossil fuels and green energy transition. Newsflash: the Fed can’t do that either. Congress must. This crisis should be a huge slap in the face. Wake up.
High inflation is a big problem. The Fed showed us again yesterday by raising rates that they are working on getting it down as quickly as possible without causing a recession. But that’s a tall order, and its tools cause pain too.
On top of that, it’s a small group with enormous responsibilities and little accountability. That’s not encouraging. If the Fed alone fights inflation, people will suffer. It does not have to be that way. Congress and the White House must do more to fight inflation. They have the power and are accountable to the American people.
One closing thought: The world is painful right now. It’s been that way for far too long. I am thankful for the public servants at the Fed. They are doing their best.
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