Federal Reserve Chairman Jerome Powell speaks at a news conference following a meeting of the Federal Open Market Committee on May 4, 2022 in Washington, DC. Powell announced that the Federal Reserve raises interest rates by half a percentage point to combat record high inflation.
Win Mcnamee | Getty pictures
Volcker or Vulcan?
Who should the Fed imitate today?
With a consistent chorus of economists, former politicians and businessmen urging Federal Reserve chief Jerome Powell to smash inflation now, they panic as if today̵[ads1]7;s inflation is the exact twin of what plagued the US economy over 40 years ago.
The comparison is, in the words of a famous Vulcan, illogical.
Powell admitted almost as much on Wednesday when he said that some of the inflation currently generated, at home and abroad, is far beyond the Fed’s control.
I have argued that almost everything is there, and that by aggressively tightening credit terms, both by raising interest rates and launching Quantitative Tightening (QT), the Fed is overreacting to the long-term risk posed by short-term effects.
I have also argued that current inflation is much more like a post-war phenomenon than a series of adverse shocks that hit the economy from the late 1960s to the early 1980s.
At the time, then-Fed Chairman Paul Volcker approved record-breaking interest rate hikes that led to short-term interest rates above 20% and long-term interest rates above 14%. It was a logical answer to the more than decade-long build-up of inflationary pressures that was a multifactor phenomenon.
In my Volcker vs. In the Vulcan scenario, a more sober assessment of current inflation would attempt to measure risk versus reward and causation versus chance.
The enduring nature of the pandemic, which is now greatly affecting China’s economy and further disrupting global supply chains far beyond what was once reasonably expected, is at the root of the high prices we are seeing today. This is a domestic policy issue first and a global economic and foreign policy issue second.
In addition, the Russian invasion of Ukraine has unexpectedly, and massively, reduced the production of energy and food supplies globally, which has led to another supply shock that has resulted in 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 recently been noticed that US grocery bills are increasing for meat and poultry as well.
It is not just higher feed prices or lack of fertilizer that are pushing up the prices of meat and vegetables – an outbreak of bird flu reduces the supply of chickens, and makes even the most affordable meat substitutes cheaper than there were just a few. months ago.
And when it comes to wage growth, according to the Fed’s own admission, labor costs increase only in part due to increased demand for consumer goods and services.
Chairman Powell noted that there are currently 11.5 million open jobs in the United States, almost twice as many unemployed workers – another shortage due to, at least in part, pandemic-related problems.
Against this backdrop, it now appears that the Fed is determined to push the economy to the brink of recession and push up unemployment to alleviate the inflationary pressure that for me remains temporary, in the broadest sense.
And I do not think that this pressure will subside in a few months, but as in previous post-war periods, inflation will fall when supply returns, even against a backdrop of increasing demand.
It is completely illogical to think that aggressive austerity measures will shorten the shutdowns in China, end the war in Ukraine, produce over four million American workers out of thin air, or even cure our chickens before they hatch.
I do not know of anyone except the St. Louis Fed President James Bullard who seriously believed that the Fed would raise interest rates by three quarters of a percent in this austerity cycle. As we saw on Thursday, the belief that it was relief was a fatally flawed construction.
Although the logic dictates that the Fed gradually normalize interest rates and one day reduce the size of the balance sheet, it becomes extremely clear that the Fed intends to create a recession, not avoid one.
If I’m forced to choose between Volcker’s approach to current inflation, or a Vulcans, I go with Mr. Spock every time.
Volcker was entitled to drive the economy into a deep downturn to conquer embedded inflation in 1980, although these actions led to several undesirable events, such as the Latin American debt crisis, which eventually forced him to turn the course and ease.
Logic suggests that the Fed will not try again, not today.
The economy is already beginning to decline. The dollar is rising rapidly and there will be a price to pay for misidentifying the cause of today’s economic problems.
The very idea of constructing a recession to reduce normalized demand to meet a drastically reduced supply makes me raise an eyebrow and insist that “This is highly illogical, Captain.”