Fed Panic: Why This Is Not A Drill

Fed Panic: Why This Is Not A Drill

It’ll be all housing data and Fedspeak in a holiday-shortened US trading week.

Anyone who isn’t on vacation will hear from at least seven Fed officials in the days ahead. The list includes Jerome Powell, who’s set to regale Congress over two days of what promises to be contentious testimony centered around the Fed’s increasingly urgent efforts to corral generationally high inflation. The Fed described its commitment to the fight as “unconditional” in its semi-annual report released ahead of Powell’s testimony.

Over the weekend, Christopher Waller was unequivocal. “The Fed is ‘all in’ on re-establishing price stability, and part of that effort involves understanding the forces that have boosted inflation and also examining how policymakers responded,” he said, in a Saturday speech for a panel discussion in Dallas called “Monetary Policy at a Crossroads.”

Waller indicated he’ll back another 75bps hike at the July meeting. During the Q&A session, he was very direct. “I don’t care what’s causing inflation, it’s too high,” he said. “It’s my job to get it down [and] higher rates [will] put downward pressure on demand across all sectors.”

On CBS’s “Face the Nation” Sunday, Loretta Mester described recession odds as “going up,” a state of affairs she conceded is “partly” attributable to the Fed waiting too long to pivot. Mester also admitted it’ll likely be “a couple of years” before America sees 2% inflation again.

Mester didn’t predict a recession, but her assessment of the inflation situation was, as she put it, “frank.” “The May CPI report basically was bad across the board,” she told Margaret Brennan. “In fact, some of the measures actually looked worse in May than in April and that was part of the calculus” for last week’s rate hike, the largest single-meeting move since 1994.

Janet Yellen, meanwhile, told ABC’s “This Week” that high inflation “so far” in 2022 “locks in higher inflation for the rest of the year.” “I expect the economy to slow,” she added, before dutifully repeating Joe Biden’s line from an AP interview last week: “I don’t think a recession is at all inevitable.”

To be absolutely clear, I’m not an “anti-establishment” personality, nor have I ever thought of myself as any sort of “contrarian.” My mission in life isn’t to deride “groupthink,” nor do I enjoy demonizing public officials. There are plenty of web portals that specialize in that sort of commentary and this isn’t one of them. That said, it’s exceedingly difficult to take seriously the commentary emanating from Yellen and Fed officials at this juncture.

Economics isn’t a hard science. I’ve written voluminously on this point. If you get it right, luck was involved. If you get it wrong, there was likewise a role for luck, only the bad kind. Larry Summers wouldn’t have been right about inflation post-COVID were it not for the myriad supply-side factors he habitually gives short shrift. Ben Bernanke wouldn’t have been right about disinflation post-GFC were it not for a host of deflationary forces and an inert (or, at the least, underwhelming and inconsistent) fiscal impulse, neither of which was guaranteed to work in his favor. It’s all guesswork.

As I put it in “Economics May Kill Us,” “it’s ludicrous to expect small cadres of technocrats to control the behavior of large numbers of people all with free will and their own ideas about how they’re going to transact with one another on a daily basis.” The problem could be partially “solved” with a central bank digital currency that allows policymakers to exert direct control over spending and saving by, for example, putting an expiration date on a portion of consumers’ funds when the economy needs a boost (“use it or lose it”), blocking certain kinds of discretionary purchases when inflation is too high (“necessities or nothing”) or dynamically adjusting interest rates on personal accounts at the central bank in real-time.

No one would accept such a system in a free society, though, so in most situations, policymakers won’t be able to steer the economy with anything like deft precision. At best, they can prod it at the risk of exacerbating deleterious societal trends (e.g., worsening inequality as the price of harnessing the “wealth effect” in the service of boosting the broader economy) or bludgeon it at the risk of hurting the very same households they’re trying to rescue (e.g., a recession as the price of vanquishing inflation).

To be clear, there’s no reason to believe Summers — or any of the Fed’s many detractors — would be any better at the job. Indeed, many current Fed critics were themselves public officials at one time or another, responsible for either dictating monetary policy or shepherding fiscal policy. If memory serves, all of them, without exception, failed more than they succeeded, with the obligatory caveat that “failure” and “success,” like economics itself, are highly subjective in this context. Summers is the quintessential example.

The problem for Powell and his colleagues (and also for Yellen, given that, for most of us, she’s still synonymous with the Fed), isn’t that their guesswork turned out to be wrong. That’s part of the job. The problem is that they were wrong repeatedly, loudly and very publicly, about the only economic issue you can’t be spectacularly wrong about in public.

Economic debates are too esoteric for the general public to care about with one exception: Inflation. The public cares about unemployment, but it takes a pretty severe increase in the jobless rate for voters to consider the issue a national crisis. Joblessness is a dinner table issue when someone at that table has lost a job. Other than that, it’s someone else’s problem. The only modern exception to that came during the original pandemic lockdowns, when the unemployment rate briefly surged to levels consistent with Depression (with a capital “D”).

To be sure, elevated joblessness and shallow recessions can be politically ruinous, but nobody is going to storm the Eccles Building if the technocrats are off by six-tenths of a percentage point on their projections for next year’s unemployment rate.

Inflation is a different matter entirely, especially in a political environment where the GOP is keen to suggest that a sitting US president is somehow beholden to a faction of his party comprised of purported “leftist radicals” with designs on turning America into Venezuela. That’s obviously ridiculous, but tens of millions of voters believe it. When a few million more who didn’t believe it initially notice their grocery bills are rising at what, for a developed economy, counts as an alarmingly rapid rate, they might start to believe a watered down version of the narrative too, especially when gas prices are the highest they’ve ever been (in nominal terms, anyway).

Simply put, you can’t tell the public that inflation is “transitory” and repeat that line several hundred times for 18 straight months against a backdrop of ever higher consumer prices. If you do, everyone is going to notice, irrespective of whether their own financial circumstances are such that a 10% increase in grocery bills is irrelevant.

There’s no “target” for unemployment. There’s NAIRU, but to the average American, “NAIRU” is a Star Wars villain. Or the demonic antagonist from a superfluous Netflix horror series. By contrast, 2% inflation means 2%, even if the method for achieving it eventually fell victim to economists’ overriding affinity for acronyms (AIT). Inflation is nowhere near 2% (figure below). And everybody in America knows it.

This is (easily) one of the most serious credibility problems the Fed has ever faced. Some readers may scoff at that contention. What about their role in exacerbating inequality? Or killing price discovery? Or making a mockery of money itself by conjuring trillions out of thin air to perpetuate the increasingly ridiculous circular funding scheme we call “the Treasury market”? And what about the countless examples of what critics charge is the institution’s hand-in-glove relationship with Wall Street? And on and on.

But remember: Inherent in the concept of a credibility problem is a widespread loss of public confidence around an issue (or issues) the public cares about and understands intuitively. Inflation is such an issue. Debating the myriad other issues related to the Fed’s credibility requires engaging with concepts that can be a challenging lift for a society short on time, patience and attention. By contrast, inflation is profoundly easy to grasp. It’s also conducive to anger and Americans always want a scapegoat.

“A couple of years. I mean, the other thing that’s hard to measure is just people’s confidence. Right?” CBS’s Brennan asked, after Mester said inflation likely wouldn’t return to 2% anytime soon. “And when they look at being told by the administration, by the Fed, that inflation was ‘transitory,’ they can say people were wrong. Right?”

Mester meandered. Ukraine. Oil. Supply conditions. Other people who were wrong too.

“What I want to say, though, is we at the Fed are very committed to using the tools at our disposal to bring this inflation under control and getting it back to 2%,” she told Brennan, eventually. “It is the number one challenge in the economy now.”

“It is,” Brennan responded, flatly.


21 thoughts on “Fed Panic: Why This Is Not A Drill

  1. I’m relieved to read that others think economists use acronyms a lot. It would be helpful to adopt a custom used in some medical articles of spelling out the acronym the first time it is used in the article if it is going to be used frequently.

  2. “…party comprised of purported “leftist radicals” with designs on turning America into Venezuela.” Would that be referring to Venezuelan inflation, shortages, civil strife, failing infrastructure and a general sense of despair? That sounds like the road we are traveling with our unfettered capitalism. Could it be that the our hostility toward socialism and our love of autocrats is the root cause of Venezuela’s and our own problems? If we attacked Norwegian Democratic Socialism with the zeal that Venezuela has been attacked, maybe we could ‘fix’ their many problems. A poverty rate of 10% vs 29% here, incarcerations rate of 74 per 100,000 vs our 860 per 100,000 here, GDP of $75,000 per person vs our $59,000 here, murder rate of 0.51 per 100,000 vs our 4.74 per 100,000 here, free universal health care, free higher education, 8 weeks of vacation per year, 35 weeks of paid parental leave and an average personal tax rate of 38.52% vs our 37%. What’s not to hate about Norwegian Democratic Socialism? The state department and DOD need to get busy fixing Norway for humanities sake. That’s obviously ridiculous and tens of millions of US voters need to realize it. …and that’s all I have to say about that.

  3. H-Man, not wanting to manage all these variables, or wade into the weeds. Occam’s razor suggests that after the boom there is a bust and that business cycle has repeated itself for eons.

  4. Maybe Powell, Fed governors and Janet Yellen all realized very well the pickle they found themselves in following decades of easy cheap money, “helicopter money” for the masses (that stoked demand) and labour shortages/supply issues that surfaced as a result of COVID crisis.
    But simply were unwilling to dole out the required medicine.
    They tried to simply talk down the inflation risk for months, trying to keep consumers calm and saying the economy is resilinet and will right itself.
    The problem is that consumers put gas in their cars and buy groceries every week. And pay rent/mortagages every month. Hard to keep the lies going, no matter how many analysts economists, charts or dot-plots you bring out!

  5. You obviously know I agree with your assessment of the Fed’s inflation response. I still think reconfirming Powell was a mistake by Biden. When you screw up as badly as the Fed has under his leadership vis a vis inflation, you shouldn’t get rewarded with another term. Biden likely won’t.

    “it’s ludicrous to expect small cadres of technocrats to control the behavior of large numbers of people all with free will and their own ideas about how they’re going to transact with one another on a daily basis.” I agree that it’s nearly impossible to control how people transact, on what, and to what degree but in the digital economy it should be much easier to measure. I would expect that if they wanted to, those technocrats could monitor the daily spending of consumers and dot plot a day to day, week to week, and month to month shift in those spending trends. That may allow them to stay ahead of the curve better.

    The real sense I get from this committee is that the numbers they work within are just those, numbers. They aren’t people they empathize with or even understand because they likely have not come from a life experience that the Americans struggling to eat have. This feels like the root of the problem with the committee, and why they seem to mostly benefit those that they can relate to, those in the elite.

  6. So Joe Six Pack don’t like “esoteric” conversations and that is one reason he can be slowly bled of innate intellect, until beer prices become exorbitant? Yup.

    1. I think the larger, but related, point is that if you slowly suffocate the lower- and center- points on the middle class continuum over several decades, you’ll leave them vulnerable to populists and demagogues, with potentially disastrous consequences over the medium- and longer-term. But if you get into a situation where — as you put it — “beer prices are exorbitant,” and so is gas, and so are potato chips, and on and on, you open yourself up to a more acute, near-term backlash that’s related to, but not inextricably bound up with, a broader societal breakdown. Soaring grocery and gas prices are immediately untenable. They can exacerbate existing trends (inequality, political vitriol, etc.), but double-digit inflation is a five-alarm blaze for policymakers in advanced economies. You have to fix that first and worry about the rest later.

      1. Rhetorically asking for a friend:
        What have the Republicans to offer that would change things in 2023? Would they urge the independent Fed to raise interest rates? Would they buy Russian oil? Would they allow immigration?

  7. Short of admitting they were wrong, accelerating interest rate increases, and beginning QT, what do we expect this Fed — or any Fed — to do? If another person was Chairman, or if the governors were all decidedly more hawkish, what would they be doing differently right now? Waller this weekend said a 100 point increase at the next meeting with give the market a heart attack — so that seems off the table. Price controls — that worked out well in the 70s, didn’t it? Releasing oil reserves didn’t make a whole lot of difference in price, did it? If Putin hadn’t invaded Ukraine, if the Pandemic hadn’t happened, if, if, if, if. Pointing fingers solves nothing at this point. We know the Fed screwed up. We know that Congress has done zip –nada — to address inflation. Short of a complete economic and currency do-over, it’s going to take time, discipline, consistency, and time to fix this.

    1. Still not sold on the “time horizon” thingy.

      if inflation is mostly due to COVID relief/short term credit card debt that is now spent/maxed out, I think the consumer could turn off his/her spending off pretty sharply, leaving Target, Wallmart and others with an inventory overhang…

  8. “I don’t care what’s causing inflation, it’s too high,” he said. “It’s my job to get it down [and] higher rates [will] put downward pressure on demand across all sectors.”

    I do hope that was an off-the-cuff quip. Otherwise it is DAMN CHILLING.

    Let’s see how fellow loudmouth Jim Bullard one-ups Waller this week!

    They share a common biography – It looks like Waller also never worked a day in the “real world” (outside of, perhaps, a stint at the university cafeteria while in school.)

    It’s exhibit one to @cdameworth’s observation that: “The real sense I get from this committee is that the numbers they work within are just those, numbers. They aren’t people they empathize with or even understand because they likely have not come from a life experience that the Americans struggling to eat have. This feels like the root of the problem with the committee, and why they seem to mostly benefit those that they can relate to, those in the elite.”

    Touche!!!

    1. Remember when Powell regaled us with his story about driving past the homeless encampment on the way to work? I thought Jerome might actually be getting religion when it came to the wealth and income inequality he had long encouraged, but it turns out he was just brainstorming new ideas — you’ve heard of QE and QT, so get ready for TH — transitory homelessness!

  9. “The problem could be partially “solved” with a central bank digital currency that allows policymakers to exert direct control over spending and saving by, for example, putting an expiration date on a portion of consumers’ funds when the economy needs a boost (“use it or lose it”), blocking certain kinds of discretionary purchases when inflation is too high (“necessities or nothing”) or dynamically adjusting interest rates on personal accounts at the central bank in real-time.

    No one would accept such a system in a free society”.

    Err? Why not? What are fiscal and monetary authorities’ mandate if not to protect us from the economic cycles we used to have in the 19C and before and that regularly devasted whole economies without recourse?

    This would simply be a refinement on trying to solve the coordination issue and the benefit of suffering less recessions and longer booms would be well worth whatever abstract loss of freedom is supposedly involved here… After all, how free is the unemployed man/woman with a family to feed?

  10. When I was a grad student it used to be a common characterization that what made the University of Chicago’s business and economic research and programs so good was their pragmatic philosophy. The only stuff that was worthwhile was stuff that actually worked! It’s not the elegance of theories that make them great, it is whether when the theory guides practice we actually get the outcome we want. This time around I’m not convinced that inflation is willing to be simply Volcker-ized. Maybe his policies worked by luck and won’t work again. Remember, the inflation of that era took a decade to tame. For those of us with real savings recessions are a pain in the tail but mostly something that can be endured. For the rest (most) of us a real recession will bring existential threats. Powell alone has not been solely responsible for inflation. It took a village, the FOMC, staff, economists from two administration and a pandemic to do that. The trick is not about who caused the problem, it’s about what actions are needed to get the desired outcome. I don’t see that yet. The talking heads of the weekend should have been at work where they belong, doing what they get paid to do.

  11. The Fed lost credibility by insisting on labeling inflation transitory past the point when it was clearly not transitory, now the Fed insists they can reign in inflation without causing a recession, we may not have to wait long for a recession to put the nail on the Fed credibility coffin.

  12. @derek, the big puzzle for me is how quickly does the FOMC want to bring inflation down and how much economic damage is it willing to tolerate.

    I’ve been thinking something like “CPI 5% by year-end” (as in, if Fed doesn’t see data trending toward that level, then it will keep pressing the tightening) and “UE 5%” (as in, if Fed sees unemployment at 5% it will back off tightening).

Leave a Reply to fredm421 Cancel reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.

NEWSROOM crewneck & prints