Jerome Powell’s Jackson Hole dilemma
One has to pity Federal Reserve Chairman Jerome Powell as he prepares to deliver his key Jackson Hole monetary policy speech later this week. In the best of times, it is difficult to make monetary policy. But it is particularly challenging when one has to do so at a time that the U.S. economy is in uncharted economic policy waters on three or more fronts.
The most obvious front on which the economy finds itself in uncharted waters relates to the massive budget policy response to the country’s once-in-a-century health crisis. Even before passage of the proposed outsized infrastructure and family public spending bills, the country this year is engaged in its largest peacetime budget stimulus on record, amounting to more than 12 percent of GDP. And it is so engaged at a time of unprecedented pent-up household demand in the economy that is now being released.
As underlined by the strong economic recovery to date and by inflation’s recent acceleration to more than double the Fed’s 2 percent target, the large budget stimulus threatens to cause economic overheating. That in turn could resuscitate the inflation demons of the 1970s, which would point to the need for an early tightening in monetary policy.
Another way in which Powell finds himself in uncharted economic waters is of the Fed’s own making. By increasing the size of the Fed’s balance sheet by a staggering $4 trillion in 2020 through its aggressive bond-buying program, the Fed has created an “everything” asset price and credit market bubble that dwarfs the housing and credit market bubble of 2006.
It is not only that U.S. equity valuations are now around double their long-term average, a level experienced only once before in the last 100 years. High-yield debt spreads are close to their all-time lows, while housing prices are now rising by more than 15 percent a year and well exceed their 2006 peak.
Continuing the Fed’s current policy of buying an additional $120 billion a month in U.S. Treasury bonds and mortgage-backed securities threatens to further inflate these bubbles. This too would argue in favor of an early dialing back of today’s ultra-easy monetary policy stance.
Another way in which the U.S. economy finds itself in uncharted waters is that it is now confronted by another wave of the pandemic both at home and abroad. This wave is of the more infectious delta-variety against which vaccination seems to be much less effective than had been earlier hoped.
The appropriate monetary policy response to the delta wave is far from obvious. On the one hand, as underlined by the closure of major Chinese ports, this wave could exacerbate supply-chain problems and add to the supply-side inflation problems from which the economy has already been suffering. On the other hand, as happened with the first COVID-19 wave in 2020, it could deal a major body blow to both household and consumer confidence. That in turn would risk halting both the U.S. and the world economic recovery in its tracks, which would bring in its wake renewed deflationary pressure.
Faced with these major economic uncertainties, as well as with countervailing inflationary forces that are difficult to disentangle, Powell is unlikely to want to rock the boat at Jackson Hole. After all, in these circumstances, it is difficult to discern whether inflation is likely to rise or fall.
Rather, especially at a time that Powell’s renomination to another term at the Fed’s helm is still under consideration, he is likely to continue exercising the patience in changing monetary policy course that he has exercised to date and wait for more data to gauge the strength of the economic recovery and the force of today’s inflationary pressures. He will do so even at the risk that by keeping monetary policy ultra-loose, he will be continuing to inflate asset and credit market bubbles.
Desmond Lachman is a senior fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.