Dhe pressure is mounting on the Federal Reserve not to tighten monetary policy at the same pace as before. Criticism has come from some economists and left-wing politicians, who see their skins flying off shortly before the upcoming midterm elections for Congress.
But it’s clear that even within the Federal Reserve’s key policy-making body, not all members are convinced that the Fed should continue at its current pace. This can be gathered from the Fed’s press release and above all from the deviations in the wording compared to previous releases. This time they say they want to take into account the time it took for monetary policy to affect the economy and inflation. And they also want to take into account the “cumulative effect” of monetary policy.
The cryptic wording hides the concern of some central bankers that the curve has already been overstepped and also the signal that smaller interest rate hikes cannot be ruled out from now on. With this formulation, Jerome Powell has evidently persuaded the internal skeptics to agree to a sharp rise in the key interest rate of 0.75 percent again this time. In fact, it turns out that Powell didn’t deviate one iota from the core message of his 8 Minutes Speech in Jackson Hole: inflation has to go. He follows up with action: Never in the last 40 years has the Fed raised key interest rates as quickly as this year. However, inflation is also close to a 40-year high at 8.2 percent in September.
Responding too late to inflation
And the effect? The economic data paint a mixed picture. The US economy is stagnating, although recent growth numbers have been positive. The labor market is still heating up with a historically low unemployment rate of 3.5 percent. And the households that are the pillar of the economy in America’s economy are proving to be stable in their propensity to consume. You can still draw on savings and a steady income thanks to high job security. However, the individually good news also means that the economy has not yet suffered the dampening that is a prerequisite for a decline in inflation. This justifies further tightening, but leaves open how intensive it must be.
Irrespective of the specific data situation, which does not allow a clear assessment of the strength of the economy and the drivers of inflation, aspects of risk management must be taken into account. Powell understood that perfectly. Under his leadership, the Federal Reserve reacted too late to inflation, thereby risking the Fed’s most important asset, confidence. With the exceptionally tight monetary policy, he is now struggling to preserve it.
In practice, this means that Powell is more likely to risk tightening than loosening monetary policy. His calculus is: If the Fed relaxes too early without curbing inflation, then trust will be lost with fatal consequences for the institution and price developments. He definitely doesn’t want to risk that. On the other hand, Powell can fight an economic crisis as a result of overly tight monetary policy more easily than a crisis of confidence.
In this unusual year a hawk hatched: his name is Jerome Powell.