Federal Reserve Chairman Jerome Powell on Wednesday announced the central bank raised interest rates by 75 basis points, as expected by economists and investors.
But there were new pieces of information to interpret that ultimately added confusion. And even though the Fed has pushed through four mega-sized rate increases this year, it’s still well behind the curve in bringing down inflation.
At Wednesday’s press conference, Powell went out of his way to say three things: 1. The Fed was not “pausing,” or holding back on raising rates. 2. The Fed was not close to pausing. 3. The Fed’s assessment is that the peak for interest rates is likely to be higher than it previously thought.
“ You will not find a point in history when the Federal Reserve let the inflation rate rise from under 2% to over 8% in the course 13 months and failed to raise the federal funds rate by a single basis point. ”
Powell said just about anything he could to take a positive spin out of the markets. He talked about three metrics the Fed needed to be concerned with. The first was the speed of rate hikes. The second is the level that the Fed needed to get the federal funds rate to become restrictive. The third is the amount of time the Fed needs to keep the Fed funds rate in a restrictive area. These are the three separate actions that the Fed thinks of when it’s setting policy now.
The other bit of new language in the Fed’s policy statement expresses those other objectives: The committee anticipates that ongoing increases in the target range will be appropriate to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.
In that statement, the Fed made it clear it’s trying to achieve objectives two and three. It needs to get the fed funds rate up to the appropriate level that is “sufficiently restrictive” and then return inflation to the 2% level, with the key words being “over time.”
In the press conference, the Fed chair said several times that the central bank would have to be patient. There’s clear tension between the Fed’s need to get inflation down and to get it down at a fast enough pace that inflation is not entrenched at high levels, and also to prevent inflation expectations from shifting up. All the while it doesn’t want to smother the economy. The Fed is not in a hurry to get back to 2%; alas, it will get back to 2% “over time.” The Fed’s objective is to be fast enough, but not too disruptively fast.
Powell aims to level-off rates
In the question-and-answer period, Powell made it clear that speed is somewhat less important since it had acted quickly. He went out of his way to say that the appropriate rate level has a great deal of uncertainty surrounding it.
However, the Fed views itself more as in phase two right now where, rather than looking for speed, it’s looking to get rates to achieve the right degree of restrictiveness. Since the Fed has raised the federal funds rate by 375 basis points, I don’t think anybody is surprised that the Fed chairman thinks he is more than halfway to his final destination and in less of a hurry. Whether he is 75%, 80% or 90% of the way there is something that we can guess about — but nobody knows.
What’s the actual inflation benchmark?
The chairman distanced himself from the old benchmarks of thinking — that the federal funds rate had to be above the inflation rate for policy to be restrictive. That’s news!
But is it good news? This is a benchmark policy from the past that has proven to be effective. When the Fed changed its “policy framework statement” to emphasize full employment and make attaining it a precondition for rate hiking, it began a process of disregarding old rules that worked.
Is that another example of Powell going down the wrong path? The Fed is once again dumping its eggs into the “Bernanke basket” and betting everything on expectations as the right fulcrum to run off policy. Powell noted the importance of forward-looking inflation and inflation expectations, but do we really have a clue what they are?
Do we throw out time-tested rules in a time of inflation crisis to depend on something that already has broken down? Low expectations did not prevent 8% CPI inflation, after all. Low inflation expectations still exist — in the middle of all this! Why, and how? And inflation is stuck at a high level. So what good are expectations if people are not acting on them?
Powell would not answer a question about what the underlying inflation rate was. He went out of his way several times to talk about the core PCE inflation rate; it is currently running around 5%.
He talked about the importance of inflation expectations and how long-term expectations had risen, but they’ve since come back down. And he basically let us know that he’s looking to get the federal funds rate somewhere in line with “underlying inflation” — whatever that is. He didn’t commit himself to saying it’s year-over-year inflation on the core PCE or anything else. But core PCE seems to be a strong candidate.
The Fed remains under a lot of political pressure. Sen. Elizabeth Warren on Nov. 1 asked Powell exactly how many jobs he intended to destroy. Politics continues to stalk the Fed. And remember that the FOMC statement is a compromise made by a committee. We should wonder just what (or who?) influenced the Fed to put those two hot-button words or phrases (“lags” and “cumulative tightening”) in the statement, only to have Powell undercut them 30 minutes later.
Life in the fast lane
The Fed remains under excruciating political pressure. Powell and the markets are obsessed with the speed by which the Fed raised the federal funds rate.
While it’s true there are a few times in history when the Fed has raised the federal funds rate this quickly, it’s also true that you will not find a point in history when the Federal Reserve let the inflation rate rise from under 2% to over 8% on the CPI in the course 13 months and failed to raise the federal funds rate by a single basis point.
The Fed put itself behind that eight ball, and it still has not caught up. If we evaluate Fed policy using a different method, if we look at the level of the real fed funds rate (which is the federal funds rate with the year over year inflation rate subtracted from it), we find that at this point in the rate-hike cycle (eight months in) the real fed funds rate is lower than it has ever been in any Fed tightening in the post-war period.
As fast as the Fed has raised rates it still has not caught up to historic standards for the level of restrictiveness usually achieved. That’s because it waited so long to raise rates and inflation rose so fast. And now we find out that the Fed may not want its policy held to that historic standard.
Things that are not what they seem
I remain unimpressed by the speed of the Fed’s rate hikes. I am much more concerned about the absence of any restrictiveness in policy. What I know from looking at economic data is that the fed funds rate is not yet restrictive. Neither growth, nor inflation, nor the job market are responding, and that’s because policy is still accommodative. The exception is for housing, where prices simply overshot.
And while the Fed talks about having the unemployment rate down to a 40-year low, the unemployment rate was actually at 3.5% under Donald Trump and the inflation rate was still low, under 2%. That happened less than two years ago — not 40 years ago. Consumer spending continues to hold up and, in fact, this month car and truck sales have spurted; they will contribute to a strong gain in consumer spending in October.
Fed policy is confusing
With war in Ukraine, high oil prices, President Biden committed to a green policy that restricts oil production in the U.S. and with a drought that is impeding the transportation of bulk goods as well as the irrigation of crops, I’m quite confused about why the Fed expects the economy to slow and prices to ease with fed funds below the rate of inflation.
There is a lot about Fed policy that is confusing. A lot of it has to do with things that nobody wants to confront and say directly — such as how high rates may eventually have to go. Markets don’t seem to want to think about it; they just want the Fed to pivot so that the horror of ongoing declines can stop.
The Fed knows what its job is; it is trying to achieve it without creating much economic disruption. The irony is if the Fed lets that get in the way of controlling inflation, there will be even more disruption. That’s one of the main paradoxes of monetary policy. If inflation kicks up its heels, policy needs to stop it now because stopping it later will always be more painful.
Robert Brusca is chief economist of FAO Economics.