Tension lingered Friday as shell-shocked investors pondered the prospect of an emergency rate hike from a Fed which, frankly, is flirting with a credibility crisis. The New York Fed released the final monthly schedule for Treasury purchase operations as planned, effectively ruling out an inter-meeting hike, but speculation around the Committee’s next move is at a fever pitch.
Critics will argue the Fed lost credibility decades ago, and that the only mandate the Committee actually pursues with anything like vigor is a shadow commitment to fostering and preserving bubbles in financial assets. If that’s your view, the current debate is superfluous.
At this point, though, even those of us inclined to observe decorum are compelled to acknowledge that Jerome Powell is wading into dark waters. Inaction isn’t an option anymore. The optics are very poor. Whatever the “flexible” meant in “flexible average inflation targeting,” it’s safe to say the Fed is out of flexibility. The figure on the left (below) is a testament to that.
The figure on the right (above) speaks for itself, but just in case, I endeavored to be unequivocal in the heading, subheading and caption. The Fed’s current policy stance is parody.
It no longer matters whether rate hikes are an effective tool given the nature of price pressures currently bedeviling the world’s largest economy. I don’t think they are. Raising rates isn’t going to fix disrupted supply chains. Or bring workers off the sidelines. Fed officials readily admit as much, but they simultaneously (sometimes in the same breath) insist they’ll do what’s necessary to control inflation using “tools” they swear are “very powerful,” to borrow the Bank of Japan’s language.
If monetary policy is impotent in the current environment, the Fed should just say so. If it’s not, they need to act. It isn’t an exaggeration anymore to suggest that inaction chances irreparable damage to the institution. If anything we claim to know about monetary policy and economics is even a semblance of true, there’s no case whatsoever for keeping rates at zero and continuing to purchase assets with newly-conjured fiat money. Not even for another day.
Persisting stubbornly in that policy bent when every, single data point is conspiring against you, is madness and reflects an almost pathological arrogance. Powell has taken to preaching “humility” lately. Well, there’s not much humility in the Fed’s current posture, which, again, amounts to deliberately tossing kerosene on a raging bonfire that’s creeping closer and closer to a parched forest.
Note that all of this is predicated on the notion that monetary policy can make a difference. I’ve repeatedly suggested it can’t given the proximate cause of inflationary pressures post-pandemic. But if the Fed intends to stick with the notion that monetary policy is capable of putting out the fire, then policymakers need to grab the extinguishers.
Currently, inflation in the US is purely a supply-demand problem. But a Fed that stands idly by a fire while insisting loudly that if they wanted to, they could put it out, runs the risk of sowing the seeds for a crisis of confidence in the currency.
Obviously, the US is nowhere near that tipping point. And because the dollar dominates cross-border trade and settlement, there’s an argument to be made that shifting away from it simply isn’t possible, regardless of what happens in the US economy or on the US political scene.
Nevertheless — and I never thought I’d have to say this — the risk of hyperinflation in the US is now non-zero. The public has almost no faith whatsoever in America’s institutions, and that includes the country’s many technocrats and bureaucracies. It’s not terribly difficult to imagine a scenario where a skeptical populace, fed up with anything and everything, starts asking uncomfortable questions about why the fire department isn’t putting out the fire.
If politicians become too concerned about the issue, it’s possible Congress decides the Fed can’t be trusted to follow its price stability mandate anymore. Of course, the last people you want in charge of monetary policy are politicians.
The stakes are getting higher by the hour. Literally, from a confidence perspective. The Fed needs to hike rates immediately and cease and desist from buying bonds. If they don’t, they may look up a year from now and discover that supply chain disruptions and wage-price spirals are the least of their problems.