Investors eyed Jerome Powell’s first day of Congressional testimony on Wednesday. Traders were “bracing for Powell,” to quote a somewhat inane headline.
Spoiler alert: Powell will reiterate the Fed’s commitment to the inflation fight. That commitment is now “unconditional,” according to the obligatory report prepared for lawmakers ahead of his trip to Capitol Hill.
He’ll also be compelled to explain how the technocrats managed to get things so wrong. I have a modest suggestion. They didn’t get it “wrong,” because to suggest as much is to tacitly assume that they had it “right” previously — to assume that the decline in macro volatility over the past several decades (figure below) was in large part attributable to independent central banks with inflation mandates. I don’t think that’s true. I don’t think they ever had “control” over inflation in the first place. Inflation is a phenomenon, not some setting that can be fine-tuned by dialing up other settings.
Those who argue developed market central banks can “absolutely” create and extinguish inflation in the real economy generally rely on the most extreme examples to make the point. If the Fed sent everyone checks for $5 million directly, the US would have hyperinflation, they studiously note, as if that’s a revelation. Paul Volcker, they’ll say, “tamed” inflation through a resolute, unwavering campaign of painful, but ultimately necessary, rate hikes, and we should all thank him for it. A less flowery retelling is that Volcker bludgeoned inflation into submission by way of a singleminded, unapologetically doltish commitment to undercutting the economy.
To call any of that “control” is a ludicrous stretch — like saying I have control over a dog because I can whip it into a feral frenzy by feeding it three pounds of hamburger meat then quickly bring it to heel by firing a shotgun through the ceiling.
In-between extremes, central banks never have control over prices. Time and again I’ve suggested that, when we recap the hyper-globalization years and the Great Moderation, we may give central banks too much credit. In the grand scheme of things — taking account of well-documented trends in demographics, debt and technology, as well as the disinflationary impact of wave after wave of globalization — it’s not obvious that central banks deserve anything more than a polite acknowledgement in a footnote.
Is it realistic to suggest that small panels of technocrats were more influential in shaping the macro landscape over a four-decade period than globalization, demographics, technology, offshoring, deregulation and the corporate profit motive combined? To me, that seems laughably implausible. And yet analysts and economists make that argument every, single day in one form or another.
As I put it last month, an alternative history of central banks’ contribution to disinflation post-Volcker might assign more credit to the spectacular busts they inadvertently facilitated than to political independence, forward guidance or inflation targeting. How ironic would that be?
Macro developments in 2021/2022 shook the idea that central banks ever had control over inflation to the core (no pun intended). The pandemic upended several key deflationary trends and within months, inflation became unanchored. Yes, policymakers waited too long to hike rates, but to call developed market inflation a “monetary phenomenon” is to give oneself completely over to theory while abandoning common sense entirely.
Thomas Barkin spoke to some of this on Wednesday evening. “We are now two years into an unstable economy. It seems highly unlikely you go from very stable to very volatile to very stable again,” he said, while chatting with reporters after a speech in Richmond.
Having addressed the issue tangentially, he confronted it head-on. “I’m concerned that our success in managing inflation over the last twenty years was partially enabled — it was good policy but it was also tailwinds which were disinflationary,” Barkin mused.
And just like that, a Fed official tacitly and gently admitted to the possibility that this was always a charade. He didn’t couch it in those terms, of course, but the overarching point is the same. It’s possible that central banks played, at best, only a supporting role in containing inflation and facilitating the decades-long decline in macro volatility.
Barkin was quick to reclaim what he conceded. “That doesn’t mean you can’t control inflation,” he said. “We’ve got a mandate. We’ve got the tools.”