Has the Fed regained its credibility as a check on inflation?
That’s the question. Answers run the gamut.
At one extreme are incredulous lamentations for the ostensible absurdity of claiming to be “at war” with inflation when CPI price growth is still quadruple the Fed’s policy rate and PCE is more than triple its target.
At the other are exasperated protestations centered on the peril and, to some observers, the suicidal insanity, of claiming that the solution to economic misery brought on by soaring food and fuel costs, is more misery in the form of job losses.
Claudia Sahm, whose star has risen considerably over the past two years, encapsulated the latter argument. “A recession is worse than inflation. A lost pay check or even lost hours would far exceed the extra monthly costs due to inflation,” she wrote, in an Op-Ed for the Financial Times this week.
Let’s assume Sahm is right. That a recession is worse than inflation. That’s not true if inflation exceeds a certain threshold (say, 50%, for example) and stays there for a prolonged period of time. And the veracity of Sahm’s claim also depends on how long it takes for a newly jobless worker to find another job, and whether someone else in the same household remains gainfully employed, and so on. But let’s assume she’s generally correct. That in most cases, and in advanced, developed economies where we can be reasonably sure that inflation won’t exceed, say, 20%, even in a worst-case, a recession is worse than inflation. The next question is: Worse for whom?
At a very basic level (stripped of most nuance), the Fed must demonstrate enough resolve in the inflation fight to plausibly claim they tried their best. Their price stability mandate isn’t going to change in time to unburden monetary policy, officials have shown no appetite for moving the 2% target higher and all well-meaning Progressive talking points aside, the only sense in which the Committee’s maximum employment mandate isn’t met is if you adopt a literal interpretation of “full employment.” (Personally, I think we should adopt such an interpretation, but that’s an entirely separate discussion.)
That, in essence, is what Zoltan Pozsar argued this week in another provocative essay. Pozsar’s contention is that inflation, in its current manifestation (i.e., driven by geopolitical factors), may well be beyond the capacity of monetary policy to control. But the Fed nevertheless has to try. “Consider that inflation today is way above target and employment is way more than ‘full’ — there are more job openings than there are people to fill them,” he wrote, of the dual mandate, adding that,
‘Full-full’ employment is a part of the inflation problem. Fulfilling both of the Fed’s mandates requires less growth: Not in measurable goods but in immeasurable services, where we measure the health of the sector through wages and demand for labor. And today, demand for services and demand for labor still remain way too strong. The market can talk all it wants about a ‘soft landing,’ but we need an ‘L’-shaped adjustment in activity, and an ‘L’-shape has two parts: First an ‘I’ which you can think of as a vertical drop (perhaps a deep recession); second, an ‘_’ which you can think of as a flatline.
I’m sympathetic to that argument if for no other reason than that Americans’ faith in their institutions has never been lower. As expounded in “America Has An Existential Credibility Problem,” the Fed can’t afford to join Congress, the presidency and, most recently, the Supreme Court, in becoming the subject of public scorn and estrangement. If it does, the country risks a total meltdown. Whether we’d be better off for such a reset is an open question, which I’ll address below. But regardless, I understand the risk and therefore the appeal of prioritizing the inflation fight, even if the odds of a worst-case inflation scenario are vanishingly small.
It’s easy for us (i.e., for market participants who are all too familiar with never-ending Fed memes and conspiracy theories) to scoff at the idea of the Fed becoming another casualty of America’s institutional credibility problem. “The Fed is already the subject of public scorn!” some of you will exclaim. “Nobody trusts the Fed!”
But the fact is, the vast majority of Americans don’t know the first thing about the Fed, let alone what it does. Nobody showed up at the Eccles building in June to protest the largest rate hike since 1994, and the second such move, delivered a scant six weeks later, was likewise notable for a total lack of public interest, or at least relative to the hot-button social issues at the center of the country’s culture wars.
In many ways, this is a highly unfortunate state of affairs. The public does care about inflation and, as I’ve endeavored to explain on any number of occasions, if it ever finally dawns on Americans that nearly everyone is united in economic precarity — if not in absolute terms, then certainly relative to a tiny fraction of the polity — the nation would quickly rediscover a lost sense of community and common purpose. It’d be a tumultuous affair, but once the figurative and literal dust settled, society might be better for it.
As it stands, though, Americans tend to view inflation (and anything to do with economics, really) as the responsibility of politicians, but with caveats. Politicians are castigated for poor economic outcomes — voted out of office, even — but rarely demonized. By contrast, being on the “wrong” side of Roe risks literal demonization by half the electorate.
Make no mistake, it is still “the economy, stupid,” as the saying goes, but even as nothing should be more important to people at the end of the day than their finances (because that’s how families get fed, after all), recessions and inflation don’t engender the same sort of acute, reactionary rhetoric and behavior as issues directly involving race, creed, religion, gender and the nebulous concept of “rights.”
Currently, the country faces the worst cost of living crisis anyone under 40 has ever lived through. Yet, there are no burning cities — or if there are, it’s due to extreme weather, not angry citizens setting cars on fire. Two years ago, when the culture wars boiled over, cities burned. The fires were “wild,” all right. But they weren’t wild fires.
Politicians (and particularly Republicans) understand all of this quite well. They know that what really matters is the maximization of one’s economic means. And even if they don’t sit at the very top of the wealth hierarchy, the power they wield by virtue of their positions in government compensates for the wealth shortfall. Powerful politicians aren’t as rich as the titans of American industry, but those industries spend billions on lobbyists and, when the stakes are high enough, CEOs will grovel at the feet of lawmakers if it means getting what they want or, just as often, being spared something they don’t.
The current system doesn’t benefit everyday people who, by and large, live like hamsters. Whether you make $40,000 or $200,000 per year, you’re a hamster. Chances are, your day goes something like the following. You wake up, wander around an enclosure embellished with odds and ends that someone else thought you’d probably enjoy looking at (or laying on). You work, where that almost always entails some iteration of digging a hole only to fill it back up again. You go back to your enclosure and run full speed for 20 minutes on a conveyor belt (or ride 20 miles on a stationary bike to nowhere). You eat something very similar to what you ate the previous day, usually out of the same bowl (or one that looks just like it). Then you curl up and sleep in a corner. You’re a hamster.
With just a few exceptions, politicians want to keep it that way. But 300 million hamsters is a lot of hamsters! If they suddenly decide, collectively, that they want more out of life, there’s not a lot anybody can do to stop them — not if they act in concert after concluding that for all their differences, they’re united in a pitiable existence that’s become intolerable.
The best way to prevent a hamster rebellion is to ensure they never recognize a common cause, or if they do, that they see it as secondary to what makes them different. Politicians know that exploiting social issues is a foolproof way to prevent the public from uniting around the only truly common cause: Shared economic precarity, either outright or relative. That’s why they spend so much time feeding America’s culture wars.
Republicans prey on deep-seated prejudices and anxieties to lure voters who, from a purely economic perspective, have absolutely nothing in common with the GOP and stand to lose whatever pittance of money and bargaining power they have to Republican economic policies. Democrats pretend to care about income inequality, but the message is everywhere and always couched in the language of the culture wars: “Only we care about African American communities” or “We’re the party of gender equality” and so on.
Note that there’s one exception: Bernie Sanders. Bernie gets it. He tried to unite Americans around the only thing they all have in common. Twice. Twice he tried to lead a hamster rebellion. In a testament to the notion that preventing Americans from finding common cause is a bipartisan effort, Republicans never had to worry much about Bernie. Why? Because Democrats made sure he never won a primary.
How does this all relate to the Fed and the fight to control inflation? Well, it’s pretty simple, really. If the public loses faith in the money and long-term inflation expectations become truly unanchored, all of the divisive social issues that politicians spend every waking hour inflaming in a bid to ensure the public is too preoccupied with divisions that don’t matter to find common purpose in the only thing that does, will be supplanted, virtually overnight, by existential questions about survival in the face of rapidly devalued money and the perception that the people who are supposed to ensure the money’s stability lack not just the will to do their job, but in fact the capacity.
Perhaps — just perhaps — that’s why a deep recession is preferable to the risk, no matter how remote, of rampant inflation. Democratic governments can manage a disaffected populace through an economic downturn. After all, recessions are inevitable and although the public may not know much about the business cycle in a textbook sense, voters intuitively grasp the ebb and flow. By contrast, managing an already restive polity through hyperinflation is quite difficult. To the extent it’s possible at all, it generally requires true authoritarian rule — the public has to be more scared of the executive than poverty.
Over the past two months, Fed officials’ rhetoric around the prospect of an economic slowdown has shifted, albeit subtly. Below-trend growth is now seen as desirable, for example. Because below-trend growth is what’s necessary to bring down inflation. At the same time, the Fed’s rhetoric around inflation has shifted too, only not so subtly. As Jerome Powell is now fond of putting it, failure to control inflation “isn’t an option.”
Now, by all means, go argue amongst your fellow hamsters about today’s trending hashtag.