Federal Reserve Chairman Jerome Powell speaks during a news conference following a meeting of the Federal Open Market Committee on May 04, 2022 in Washington, DC. Powell announced that the Federal Reserve was raising interest rates by half a percentage point to combat record inflation.
Win Mcnamee | Getty Images
Volcker or Vulcan?
Who should the Fed emulate today?
With a constant chorus of economists, ex-policymakers and businesspeople calling on Federal Reserve Chairman Jerome Powell to crush inflation now, they are freaking out as if inflation today was the exact twin of what plagued the US economy more than 40 years ago.
The comparison is, in the words of a well-known Vulcan, illogical.
Powell came close to admitting this on Wednesday when he said that some of the inflation currently being generated, at home and abroad, is well beyond the Fed’s control.
I argued that almost everything is and that by tightening credit conditions aggressively, both by raising interest rates and initiating quantitative tightening (QT), the Fed is overreacting to risk long-term posed by short-term effects.
I have also argued that current inflation is much more like a post-war phenomenon than a series of negative shocks that hit the economy from the late 1960s to the early 1980s.
At that time, then-Fed Chairman Paul Volcker decreed record rate hikes that pushed short rates above 20% and long rates above 14%. It was a logical response to the build-up of inflationary pressures that had lasted for more than a decade and was a multi-factor phenomenon.
In my Volcker vs. Vulcan scenario, a more sober assessment of current inflation would attempt to measure risk versus reward and causation versus coincidence.
The long-lasting nature of the pandemic, which is now broadly affecting the Chinese economy and further disrupting global supply chains far beyond what was once reasonably expected, is the very reason for the high prices we see today. today. This is first a matter of domestic Chinese policy and secondly a matter of global economic and foreign policy.
In addition, the Russian invasion of Ukraine unexpectedly and massively reduced energy production and food supply globally, leading to another supply shock leading to higher prices abroad. and here at home.
It will not end until this war is over and it will not be resolved by any central bank.
It has been noted lately that US grocery bills are also increasing for meat and poultry.
It’s not just rising feed prices or a lack of fertilizer that are driving up meat and vegetable prices – an outbreak of bird flu is reducing the supply of chickens, making even meat substitutes the more affordable less expensive than it was only a few. months ago.
As for wage inflation, by the Fed’s own admission, labor costs are rising only in part because of increased demand for consumer goods and services.
President Powell noted that there are currently 11.5 million open jobs in the United States, nearly double the number of unemployed – another shortage due, at least in part, to pandemic-related issues.
Against this backdrop, it now appears that the Fed is determined to push the economy to the brink of recession and drive up the unemployment rate to relieve inflationary pressures which, to me, remain transitory, in the broadest terms.
And I don’t mean that these pressures will ease in a few months, but as in previous post-war periods, inflation is falling as supply returns, even in the face of growing demand.
It is utterly illogical to believe that an aggressive tightening will shorten lockdowns in China, end the war in Ukraine, produce over four million American workers out of thin air, or even cure our chickens before they die. hatch.
I don’t know of anyone, outside of St. Louis Fed President James Bullard, who seriously believed the Fed would raise rates by three-quarters of a percent in this tightening cycle. As we saw on Thursday, the belief that there was relief was a fatally flawed construct.
While logic dictates that the Fed will gradually normalize rates and one day reduce the size of its balance sheet, it becomes overwhelmingly clear that the Fed intends to create a recession, not avoid one.
If I’m forced to choose between Volcker’s approach to today’s inflation, or that of a Vulcan, I’ll go with Mr. Spock each time.
Volcker was justified in plunging the economy into a deep downturn to defeat entrenched inflation in 1980, even though these actions led to several adverse events, such as the Latin American debt crisis, which ultimately forced him to reverse trend and relax.
Logic tells the Fed not to try again, not today.
The economy is already starting to slow down. The dollar is rising rapidly and there will be a price to pay for misidentifying the root cause of today’s economic problems.
The very idea of staging a recession to reduce normalized demand to meet dramatically reduced supply makes me raise an eyebrow and insist “that’s highly illogical, Captain.”