The United States fights inflation with history

Fed chief Jerome Powell wants the world to understand that his current decisions are guided by past trauma

Adam Tooze, foreign policy

August 28, 2022, 5:10 p.m.

Last modification: August 28, 2022, 5:19 PM

US Federal Reserve Chairman Jerome Powell speaks to reporters after the Federal Reserve cut interest rates as part of an emergency measure to protect the world’s largest economy from the impact of the coronavirus, during a press conference in Washington, United States, March 3, 2020. REUTERS/ Kévin Lamarque

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US Federal Reserve Chairman Jerome Powell speaks to reporters after the Federal Reserve cut interest rates as part of an emergency measure to protect the world’s largest economy from the impact of the coronavirus, during a press conference in Washington, United States, March 3, 2020. REUTERS/ Kévin Lamarque

At the annual gathering of central bankers and economists in Jackson Hole, Wyoming this year, all eyes were on US Federal Reserve Chairman Jerome Powell. Last year, at the Jackson Hole conference, Powell heralded a new era in economic policy. This was based on the assumption that we were in a time of low inflation. Going forward, the Fed should target average inflation, offsetting periods of low inflation below 2% per year with periods of faster price increases. Today, this world seems very distant. Inflation in the United States is over 8%, the fastest rate since the 1970s. Given this extraordinary turnaround, Powell was to signal that the Fed was serious about stopping inflation .

How to do the case? Jackson Hole is a meeting of central bankers and economists. But to take a position, Powell invoked neither economic theory nor econometrics. Instead, he summoned history.

He gave a speech peppered with references to the 1970s and 1980s and paid tribute to three of his predecessors: Paul Volcker, Alan Greenspan and Ben Bernanke. Its purpose was to signal that while we may no longer be in the era that Bernanke once called the “Great Moderation,” that doesn’t mean we’re stepping back into the future. We are not going back to the 1970s. The Fed will meet the challenge of inflation quickly and head on. This time will be different.

In the fall of 2021, Powell was still talking about inflation as transitory. And it remains true that much of the price spike was driven by supply-side issues, such as supply chain bottlenecks and soaring oil prices. There is every reason to expect these pressures to diminish in the coming months. But overemphasizing this point would not help Powell make his case. Instead, he focused on the inflationary dynamics that developed on the demand side. Investment and consumption exceed capacity. Wage growth has accelerated considerably. To mitigate this, the Fed is raising rates, tightening credit and encouraging savings. The result, as Powell acknowledged, will likely be a period of “below-trend growth” and some “easing of labor market conditions.” This is the language of central bankers for a recession.

The question in financial markets is whether the Fed has the stomach for an extended fight. Will Powell and the Federal Open Market Committee be willing to let unemployment rise sharply if necessary to bring inflation down?

As Powell noted, in the bond market, inflationary expectations remained low. Bond prices signal that fund managers believe the Fed will be successful in stopping inflation, with tough measures if necessary.

On the other hand, the rebound in US stock markets over the summer suggested that equity investors were betting that the Fed would not be willing to impose a high price. Powell’s job was to dispel those doubts.

It was Volcker who made the Jackson Hole conference a meeting of rigor for economic policymakers around the world, when he became the first Fed chairman to attend in 1982. According to legend, Volcker was drawn from the perspective of fly fishing. . At the time, Volcker was facing heavy criticism over the devastating recession he was imposing on the US economy. It was his fierce resistance to criticism that established the model of the modern central banker. Forty years later, Powell used the example of Volcker to re-emphasize that it is central bankers’ primary mission to keep inflation under control – a mission he has no intention of giving up.

It was also during the inflation of the 1970s that central bankers understood the crucial importance of inflation expectations. As Volcker observed in 1979: “Inflation partly feeds on itself, so part of the job of returning to a more stable and productive economy must be to break the grip of inflationary expectations. ” Powell explained, “The longer the current episode of high inflation continues, the more likely it is that expectations of higher inflation will take root.

The goal is not just to bring inflation down, but to drive it out of the system altogether. The standard remains Greenspan’s definition of price stability. Greenspan described it as a state in which “expected changes in the average price level are small enough and gradual enough that they do not materially enter into the financial decisions of businesses and households”. At this point, what prevails is what is called rational inattention: inflation is such a minor concern that it is foolish to devote limited resources to monitoring it.

As Powell sadly observed in his speech, this is very far from our reality. Right now, “inflation is grabbing almost everyone’s attention.” By recognizing this fact, Powell achieved at least one intended effect. He delivered the message that the Fed is on the case. It will continue to raise interest rates in unusually large increments of 50 or 75 basis points until inflation is clearly under control. In response, US stock markets recorded their worst day in months. The tech-heavy Nasdaq 100 plunged 4%.

This signaled a heightened expectation of recession. But how much worse is it likely to get? As Powell pointed out, the purpose of the Fed’s urgent tightening is to avoid the kind of prolonged pressure that Volcker had to apply to the US economy in the 1980s. And, after all, no one really believes that the inflationary pressures of 2022 are as severe as those faced by Volcker in 1979. At the time, confidence in the dollar was collapsing; today, the dollar is rising high. There is no real prospect in 2022 of runaway 1970s-style inflation or an 1980s-style hard landing.

The tone in Jackson Hole can be extremely serious, and Powell’s words were certainly chosen with care. But it’s hard to avoid the impression that confronting today’s price rises through the memory of the Great Inflation of the 1970s is enacting a historical pantomime in which, rather than aiming realism, actors perform familiar roles with exaggerated gestures, and the audience knows in advance when to boo and when to clap. This, however, is a pantomime in which tens of millions of jobs and the fate of the global economy are at stake.


Adam Tooze is a columnist at Foreign Policy and professor of history and director of the European Institute at Columbia University. His latest book is Crashed: How a Decade of Financial Crises Changed the World, and he is currently working on a history of the climate crisis. Twitter: @adam_tooze

Disclaimer: This article first appeared on Foreign Policeand is published by special syndication agreement.