Jerome Powell risks going down in history as the Federal Reserve’s worst chairman since Arthur Burns, who brought us runaway inflation in the 1970s.
Due to his data-driven monetary-policy approach, the Fed chairman's 'soft landing' is looking less likely.
J erome Powell risks going down in history as the Federal Reserve’s worst chairman since Arthur Burns, who brought us runaway inflation in the 1970s.
He risks doing so by first having kept monetary policy too loose for too long as he waited for clear signs of inflation to actually show up in the data. He thereby lost control over inflation and added to an asset-price bubble. He now risks allowing the same data-driven approach to cause him to slam on the monetary-policy brakes too hard to regain control over inflation even at the likely cost of a deep recession.
Last year, the Fed clung to the belief that the inflation we were experiencing was a transitory phenomenon. It did so despite early indications that the combination of the largest peacetime budget stimulus on record and an ultra-loose monetary policy would soon lead to economic overheating. Instead, the Fed insisted that, before it considered normalizing its monetary-policy stance, it would await data showing that inflation expectations were becoming unanchored.
These views led the Fed to keep interest rates at their zero lower bound and continue buying $120 billion a month in Treasury bonds as well as mortgage-backed securities through most of last year. The net result was that inflation surged to a multi-decade high while bubbles formed in the equity, housing, and credit markets. Equity valuation reached highs experienced only once before in the last hundred years while housing prices increased to levels above those in 2006 even in inflation-adjusted terms.
Fast-forward to today, we find that the Fed is making the same mistake that it made last year but in reverse. Now with each higher inflation print, the Fed is accelerating the pace of its monetary-policy tightening. It is doing so without waiting to see the results of its earlier monetary-policy actions.
This approach is inducing the Fed to now raise interest rates in 75-basis-point steps rather than by the more normal 25 basis points, even though there are clear signs that the economy is on the cusp of a recession and that inflationary pressures are abating, as indicated by the sharp drop in international commodity prices. It is also inducing the Fed to remain committed to withdrawing $95 billion a month in market liquidity through quantitative tightening, even though equity and bond markets are wavering.
Among the indications that the economy is already slowing are the Atlanta Fed’s estimates that this past quarter the economy might have contracted for a second quarter in a row. Other indications of slowing are the decline in consumer sentiment to its lowest level on record because of high inflation, the crumbling in housing demand as a result of higher mortgage rates, and the loss of export competitiveness on account of a strong dollar.
As if a weakening economy were not reason enough for the Fed to exercise caution in slamming on the monetary-policy brakes, international commodity prices are declining sharply across the board. They are doing so in anticipation of a weakening global economy. Over the past two months, international oil, copper, lumber, and wheat prices have all declined by over 20 percent. This very likely means that U.S. consumer-price inflation has already peaked.
If aggressively raising interest rates at a time when the economy is on the cusp of a recession makes little sense, withdrawing large amounts of liquidity at a time when the equity- and credit-market bubbles are bursting makes even less sense. Since the start of the year, not only have the NASDAQ and S&P 500 lost around 30 percent and 20 percent in value, respectively, but the bond market, too, has lost around 20 percent while the cryptocurrency markets have lost some 70 percent.
The steep decline in financial-market prices is bound to have a meaningfully negative impact on the economic outlook. It will do so by having wiped out over the past six months an estimated combined $15 trillion in household financial wealth. Feeling poorer, households must be expected to cut back their spending in an effort to rebuild their depleted savings.
All of this makes it all too likely that history will not treat Jerome Powell kindly. First, he brought us multi-decade-high inflation. Now he seems to be going out of his way to ensure that the economy has a hard landing.