The Fed’s campaign to curb the highest inflation of the past four decades risks triggering a recession in the world’s largest economy. Growth has already slowed – initial GDP readings showed the economy contracted in the first two quarters of the year – even as inflation showed signs of slowing.
The persistence of high inflation has triggered a blame game in Washington, with Republicans blaming both the Biden administration’s large spending packages and the Fed’s delay in raising interest rates.
Indeed, Powell’s words were a stark turnaround from his remarks at the same conference last year, when he said high inflation could prove temporary. Now, his message is intended not only to warn the American people that economic pain is on the way, but also to deter financial markets from expecting the Fed to reverse course next year.
Prior to his remarks, many investors expected the central bank to start cutting funding costs by the end of next year as a possible recession loomed. This has led to market rates falling and stock prices rising from June levels, the exact opposite of what the central bank wants to see as it aims to slow spending and investment.
But the Fed chief said the battle against inflation would likely mean “an extended period” of slow growth, with interest rates keeping the economy on a leash. He also said that “most likely” there would be some suffering in the labor market, which could mean an increase in the unemployment rate, or millions of lost jobs.
“These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean much greater pain, ”she said, arguing that letting inflation worsen would only cause further difficulties in the future as the Fed would have to act more aggressively.
“History shows that employment costs to reduce inflation are likely to rise with a delay,” he said.
Many conference attendees, hoping for a harsh speech from Powell, were happy. At six pages, his speech was considerably shorter and more direct than the remarks here generally are. This gave little space to read anything unintended in his words. Both the Dow Jones Industrial Average and the S&P 500 stock index tumbled after the speech.
“He was extremely disciplined, extremely tight. Just say, “we are on this path, we are on this path” and don’t try too hard, don’t promise too much, “said Adam Posen, president of the Peterson Institute for International Economics.
Powell’s former Fed colleague Randal Quarles called it “exactly what was required at the time.” He said the central bank probably needed to bring its main lending rate close to 4% – it currently stands between 2.25% and 2.5% – and “they are on track to do so.”
The economy is already slowing, although it still shows “strong underlying momentum,” according to Powell.
As for inflation itself, there are some early signs of a slowdown. According to data released on Friday, the Personal Consumer Spending Index – the Fed’s preferred inflation measure – showed that prices actually declined slightly from June to July, partly driven by lower gas prices. But they are still up 6.3 percent from the previous year.
“While the lower inflation readings for July are welcome, the one-month improvement is far less than what the committee will need to see before we are confident that inflation is coming down,” Powell said.
It has firmly placed the responsibility for fighting price spikes on the Fed’s court, although inflation has also been fueled by factors it cannot control, such as supply chain disruptions and the Russian invasion of Ukraine.
“It is true that the current high inflation is a global phenomenon and that many economies around the world are facing inflation as high or higher than that seen here in the United States,” Powell said. “None of this diminishes the Federal Reserve’s responsibility to carry out the assigned task of achieving price stability. There is clearly work to be done in moderating demand to better align with supply. We are committed to doing this work. “