The Powell Doctrine

“My remarks will be shorter, my focus narrower and my message more direct,” Jerome Powell said Friday, adopting a stern, somber cadence for one of the most hotly-anticipated Jackson Hole addresses in recent memory.

All the fanfare and endless speculation ultimately came down to two related questions. First, would Powell be willing to reset expectations for the terminal rate? And second, would he emphasize the necessity of keeping rates in restrictive territory once neutral is exceeded.

Powell didn’t endeavor to weigh in directly on whether market pricing for the Fed’s destination is too low, nor was he expected to in any explicit sense. The Fed is, after all, out of the forward guidance game. Instead, he made it clear that the Fed’s policy stance isn’t yet “sufficiently restrictive” to bring inflation back to target. You could argue that’s stating the obvious, but in this case, it needed restating.

Depending on your preferred estimate of neutral, policy isn’t yet restrictive at all, but Powell effectively sidestepped that debate by noting that given how high inflation is, “estimates of longer-run neutral are not a place to stop or pause.” The implication seemed clear enough: No official’s estimate of neutral is high enough to constitute a potential plateau — even a temporary one. The Fed, Powell said, is moving “purposefully” to get policy into restrictive territory.

On the second question, Powell couldn’t have been more clear. There will be no premature dovish pivot. “Restoring price stability will likely require maintaining a restrictive policy stance for some time,” he said, noting that “the historical record cautions strongly against prematurely loosening policy.”

He also delivered his most direct warning yet to Americans: This will be painful. The only question is how painful, and on that score he said only that forgoing pain now at the risk of entrenched inflation would lead to severe suffering in the future.

Powell was widely criticized this year for “sugarcoating” (as Bill Dudley not-so-generously put it) the situation facing the economy — for downplaying the likelihood of a recession and attendant job losses on the path to vanquishing inflation, while deliberately overstating the odds of a so-called “soft landing.”

Although Powell’s staunchest critics won’t be satisfied until he predicts a deep downturn (which he won’t do, or at least not until such an outcome is a foregone conclusion, and thereby doesn’t need “predicting”), there was scant evidence of any willful “sugarcoating” during Friday’s remarks.

Reducing inflation “is likely to require a sustained period of below-trend growth,” Powell said, before describing the odds of job losses as “very likely.” Of course, he didn’t say “job losses.” He said “some softening of labor market conditions,” which leaves room for interpretation, but Powell also described the jobs market as “clearly out of balance,” an indication that the Fed views the current state of affairs as undesirable.

He summarized the tradeoff in straightforward terms — in “plain English,” as he famously described his communications style after taking the reins from Janet Yellen. “While higher interest rates, slower growth and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” Powell told the country. “These are the unfortunate costs of reducing inflation.”

He dedicated a significant portion of an otherwise short speech to lessons learned from the 70s and 80s. His remarks in that regard were very notable. The Fed won’t shirk responsibility for inflation on the excuse that supply factor-driven price growth is beyond their capacity to control. Not even if such an excuse has merit.

“Our responsibility to deliver price stability is unconditional,” Powell said, noting that although it’s “true that the current high inflation is a global phenomenon, and that many economies around the world face inflation as high or higher than seen here in the United States,” it’s “also true” that part of America’s inflation problem is due to demand outstripping supply. While the Fed’s tools “work principally on aggregate demand,” the Committee’s inability to alter the supply picture doesn’t “diminish the Federal Reserve’s responsibility to carry out our assigned task of achieving price stability.”

There’s “a job to do” on the demand side, Powell said. And the Fed is “committed to doing that job.” Again, he couldn’t have been any clearer. The Fed is actively attempting to constrain demand. For goods, for services and, ultimately, for labor.

Of the expectations channel, Powell warned of a wage-price spiral, something he and his colleagues have so far been loath to do. Although he stopped well short of employing the kind of language the Bank of Canada used to convey the same risk while hiking 100bps last month, Powell’s allusion to the 70s made it clear that the Fed isn’t, in fact, totally asleep at the wheel.

“During the 1970s, as inflation climbed, the anticipation of high inflation became entrenched in the economic decision making of households and businesses,” Powell said. “The more inflation rose, the more people came to expect it to remain high, and they built that belief into wage and pricing decisions.”

He then quoted Volcker, and said the goal is to return inflation to levels that aren’t noticeable to most businesses and households. The current state of affairs, in which inflation is above the proverbial fold every day, and is a fixture of the nightly news, is perilous, Powell suggested. “The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched,” he warned, calling that a “particular risk.” Again: Powell has never been that explicit, or at least not in public.

Finally, he emphasized that the Fed views the risks of slow-walking the process as wildly asymmetrical. The odds of a wage-price spiral “increase with delay,” he said, on the way to again referencing Volcker, this time to suggest that moving forcefully now is the only way to prevent “a lengthy period of very restrictive monetary policy.”

I’ll be open to different interpretations, and at the end of the day, STIRs will render their own verdict. But while penning this review (which, true to form, is now nearly as long as Powell’s actual speech), I purposefully avoided checking the screens so as not to be unduly influenced by the vagaries of fickle markets. Powell said what needed to be said. If it wasn’t “enough,” (whatever that means in this context) the fault lies with traders, carbon-based and otherwise.

As for the peanut gallery, which unfortunately includes a bevy of former officials-turned paid pundits, I’ll confess to being uninterested. If they were in Powell’s shoes, they wouldn’t be as brave as they are on television. After all, most of them were involved in creating and perpetuating the edifice they now so readily disavow.