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Jerome Powell wages war on inflation. Expect casualties.
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Without further ado…
Three Lessons About Inflation From Jerome Powell
In his speech at Jackson Hole, Fed Chairman Jerome Powell made his point hawkishly clear — inflation is still a problem, one that isn’t going away anytime soon.
And raising interest rates is the solution to that problem, even if it induces “some pain.”
Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.
Translation: We’re at war with inflation, and there are bound to be some casualties.
Those two words, “some pain,” have swept headlines because of their broad implications on the everyday consumer. All else equal, a 1% increase in the unemployment rate equates to 1.6 million fewer jobs. If we assume unemployment doubles from the current rate of 3.5%, that’s another 5.6 million Americans out of a job.
Of course, the idea is that the end justifies the means — “some pain” is better than “far greater pain.” Utilitarianism at its finest.
In support of the Fed’s approach, Mr. Powell highlighted three lessons guiding policymaking. Let’s explore them. (Some quotes emboldened for emphasis)
Lesson #1: Our money, our responsibility.
The Federal Reserve controls the country’s money. As such, it’s responsible for combating inflation, primarily through the use of the interest rate lever — raising rates, reducing demand, and lessening the pressures on supply.
It is also true, in my view, that the current high inflation in the United States is the product of strong demand and constrained supply, and that the Fed's tools work principally on aggregate demand. None of this diminishes the Federal Reserve's responsibility to carry out our assigned task of achieving price stability. There is clearly a job to do in moderating demand to better align with supply. We are committed to doing that job.
Translation: Demand is too high. Expect more interest rate hikes.
Lesson #2: Control the self-fulfilling prophecy of inflation expectations.
The second lesson is that the public's expectations about future inflation can play an important role in setting the path of inflation over time.
I particularly like this lesson because of its psychological roots. It’s akin to the self-fulfilling prophecy — a person's or a group's expectation for the behavior of another person or group serves actually to bring about the prophesied or expected behavior. In other words, if we expect inflation to remain high, we may inadvertently help support inflation by unconsciously modifying our behaviors.
If the public expects that inflation will remain low and stable over time, then, absent major shocks, it likely will. Unfortunately, the same is true of expectations of high and volatile inflation. During the 1970s, as inflation climbed, the anticipation of high inflation became entrenched in the economic decision making of households and businesses. The more inflation rose, the more people came to expect it to remain high, and they built that belief into wage and pricing decisions. As former Chairman Paul Volcker put it at the height of the Great Inflation in 1979, "Inflation feeds in part on itself, so part of the job of returning to a more stable and more productive economy must be to break the grip of inflationary expectations."
Translation: The Fed doesn’t want us to expect high inflation, which would influence our financial decisions. To alter the public’s perception, the Fed has been blunt with its hawkish views on interest rates.
Lesson #3: Don’t delay the inevitable.
That brings me to the third lesson, which is that we must keep at it until the job is done.
Translation: Buckle up.
History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting. The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.
Translation: If the Fed doesn’t quell inflation now, the consequences will only get worse.
Three Eye-Opening Tweets
And finally, we close with three eye-opening tweets.
Not unrelated to today’s newsletter.
Not unrelated to the previous tweet.
Not unrelated to the previous tweets.
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