“There will very likely be some softening of labor market conditions,” Powell said in his comments. “While higher interest rates, lower growth and softer labor market conditions will reduce inflation, they will also cause some pain for households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability will mean far greater pain.”
The remarks were unusually direct for the Fed chairman. They appeared to confront growing anxiety in financial markets – and the rest of the country – that the central bank was ill-equipped to tackle the economy’s biggest problem and rein in the highest inflation in 40 years.
US policymakers misjudged the inflationary threat until it was too late
The Fed was late to realize that rising prices would burrow into every nook and cranny of the economy, shaping the way Americans feel about the economy in their daily lives. Inflation falls hardest on families with little to stretch the budget, especially when it comes to high costs for groceries, gas or rent. Powell’s message was that the Fed must control inflation immediately to prevent further scarring.
For months, the Federal Reserve has been under increasing pressure to control inflation without tipping the economy into recession. Many economists and Wall Street analysts say the Fed’s odds are slim — especially because the central bank has rarely been able to initiate full cycles of rate hikes to fight inflation without causing a recession.
Jackson Hole: Where Fed Officials Gather, and Workers Can’t Afford to Stay
Powell’s long-awaited speech is also crucial for his own credibility. In remarks to the conference last year, he doubled down on his belief that inflation would be temporary. Speech does not age well.
“The Fed feels like a passenger on the bus, along with Wall Street and investors and economists. The Fed doesn’t feel like the driver of the bus,” said Michael Strain, director of economic policy studies at the conservative American Enterprise Institute. “One way you can assert yourself even as the driver of the bus on is by clearly stating what you did wrong, explaining why you were wrong, and communicating how you’re going to do things differently in the future.”
Powell ended his relatively short speech by saying that the Fed would not prematurely decide that the work was done.
“We are taking strong and swift steps to moderate demand to better match supply and to keep inflation expectations anchored,” Powell said. “We will continue to do that until we are sure the job is done.”
US policymakers misjudged the inflationary threat until it was too late
To lower inflation from 40-year highs, the Fed must be trusted on one powerful tool: interest. Higher rates are designed to slow demand by making a variety of loans, such as for cars or mortgages, more expensive. The housing market, for example, is cooling, as a rise in mortgage rates puts aspiring homeowners on hold.
Inflation eased slightly in July, clocking in at 8.5 percent year-on-year – down from last month’s high — like letting go gas prices helped to lower total costs. But Fed officials say they need to see months of sustained improvement before they know if rate hikes are working. On Thursday, new inflation data using the Fed’s preferred gauge also showed prices fell slightly in July.
The challenge reinforces that interest rate increases work with a lag, and the increases the bank is making now could slow down economic activity much more later this year or early next year. Already, the US economy shrank in the first two quarters of 2022, raising fears of a recession and suggesting the economy is already slowing significantly, even while inflation is high.
“While the lower inflation readings for July are welcome, a single month’s improvement falls far short of what the committee needs to see before we are confident that inflation is on the way down,” Powell said.
Inflation slowed in July from a year ago, as energy prices fell
Part of the problem is that interest rates are a blunt tactic, and they cannot address all the ways in which people feel inflation in their everyday lives. Interest rate increases cannot build new homes or keep gas prices low. And they can’t boost consumer sentiment, especially at a time when many families and business owners don’t feel like the economy is working for them, despite a strong job market and robust consumer spending.
Politically, high inflation has weighed on the president Biden’s approval ratings and complicated the Democratic Party’s legislative agenda. That’s not strictly a problem for the Fed, which is designed to be independent and whose officials serve terms that don’t directly align with the presidential administration. But that puts the central bank’s work under closer scrutiny from politicians.
Earlier this month, the White House and congressional Democrats secured a major victory with the passage of the Inflation Reduction Act, which focuses on the climate crisis, lowers health care costs and raises taxes on large corporations. But Republicans continue to hammer Democrats for hefty stimulus packages earlier in the pandemic, arguing that more federal spending or canceling student loan debt would further overheat the economy.
The Fed raises interest rates by three-quarters of a percentage point to fight inflation
For Fed officials who descended on Jackson Hole this week, the past few years have been dizzying. It is still very difficult for officials to get an overview of the economy. And the costs of getting these assessments wrong have been high.
In last year’s Jackson Hole speech, Powell laid out the reasons why he believed inflation would be a temporary feature of the economic recovery from the pandemic-induced recession. The Fed came close to winding down some of its emergency aid to the economy, but interest rate hikes were far from being considered. Powell also delivered his speech virtually, since the summit was canceled during last summer’s delta variant wave of the coronavirus.
Twelve months later, and now back at Jackson Hole for the first time since the pandemic began, the Fed is in a race to rein in inflation, which has soared higher and spread further throughout the economy. Swirling in the supply chain, high consumer demand and Russia’s invasion of Ukraine have kept prices high for gas, groceries, rent and everything in between. And suddenly the central bank has raised prices at its most aggressive pace in decades.
The Fed has raised interest rates four times this year, most recently by three quarters of a percentage point in July. The widespread expectation is that more increases will follow and the Fed will raise interest rates again at policy meetings in September, November and December. But it is unclear whether central bankers will keep pace with such sharp increases, or whether they will decide to scale back the increases to avoid slowing the economy too sharply and causing a recession.
Powell was not expected to use his speech to outline exactly what the Fed plans to do next month. He said Fed officials will have to rely on data still to come before the policy meeting on 20-21. September. He said that “at some point” it would be appropriate to slow the rate hikes, but gave no timeline.
Still, markets are watching closely for signs of what’s to come. Stock futures rose slightly on Friday morning, ahead of Powell’s speech.
“He’s wanted to tell a somewhat hopeful story: ‘this is something we can achieve,'” said Tim Duy, a Fed expert at the University of Oregon and chief economist at SGH Macro Advisors. “‘We know that inflation hurts all of you, and we want to correct that situation, but we don’t want to do it in such a way that it creates more pain.’