Jerome Powell’s inflation-unemployment tradeoff
On Sept. 21, Federal Reserve Board Chair Jerome Powell increased the Fed fund rate by 0.75 percent and promised additional increases by year’s end to lower the present annual inflation rate of 8.3 percent, which could cost the economy 1.2 million jobs, according to one estimate.
Powell’s decision suggests he prefers trading the pain of 1.2 million lost jobs for a little lower inflation for all. This is a costly action that ignores a less painful option. It is also Powell’s third error in the past few years.
In 2019, Powell began to tighten the Fed rate prematurely, recognized his mistake and reversed course.
In the spring of 2020, facing pandemic-induced economic collapse, he pumped trillions of dollars into the economy for far too long, held the Fed rate close to zero and, as a result, propelled the present high inflation.
And earlier this year, Powell waited too long to tighten, and is now overreacting by increasing rates too fast and promising to do so for the foreseeable future.
Powell should be patient, recognize that some inflation is beyond his control and reexamine the 2.0 percent inflation target.
Increasing the fund rate reduces price inflation of different products and services at different speeds, ranging from anticipatory (when prices go down before the hike as does the stock market) to concurrent (when prices go down with rate hikes, as do loans on homes, cars and credit cards) to lagged and variable (when rate hikes lower prices for goods and services sometime after the hike) to never (when rate hikes don’t lower prices of such things as medical services and prescription drugs).
Prices of most products and services in the Consumer Price Index that Powell wants to lower lag his rate hikes. Therefore, Powell must be patient instead of tightening quickly and sending the economy into a tailspin.
As well, the Board is unable to affect some prices such as grains and energy, because those prices are determined by international supply and demand. This suggests that inflation will be elevated for the foreseeable futures regardless of the Board’s policy.
Finally, the Board should reexamine its inflation target of 2.0 percent. It could be more productive to increase this target, say to 3.0 percent, to achieve higher economic growth, avoid severe recessionary pressures and lose fewer jobs than the projected 1.2 million. (For many years inflation rates of 3-4 percent were seen as normal.)
The choice is for Powell and his Board to make: Follow their present path of hurting 1.2 families a lot and controlling inflation faster; or loosen their stance and wait for the lagged effects to reduce inflation, thus hurting fewer families with unemployment and living with a slower inflation control.
Powell should seriously consider the second option, and if it doesn’t lower inflation, he can always increase the Fed rate more later.
Given that he repeated the need for “restrictive monetary policy” nine times in his press conference with an anxious expression on his face, I doubt it.
Instead, Powell will likely follow his past patterns of fast tightening followed by quick loosening, or quick loosening followed by fast tightening.
Avraham Shama is the former dean of the College of Business at the University of Texas, The Pan-American. He is professor emeritus at the Anderson School of Management at the University of New Mexico. His new book, “Cyberwars: David Knight Goes to Moscow,” was recently published by 3rd Coast Books.