Powell dispels doubts about his war against high inflation

The Fed’s campaign to rein in the highest inflation in four decades risks triggering a recession in the world’s largest economy. Growth has already slowed – early GDP readings showed the economy contracted in the first two quarters of the year – even as inflation showed signs of slowing.

Persistently high inflation has sparked a blame game in Washington, with Republicans blaming both the Biden administration’s big spending programs and the Fed’s delay in raising interest rates.

Indeed, Powell’s words were a stark about-face from his remarks at the same conference last year, when he said high inflation was likely to prove temporary. Now, his message is aimed not only at warning the American people that economic crisis is imminent, but also at dissuading financial markets from expecting the Fed to back down next year.

Before his remarks, many investors expected the central bank to start cutting borrowing costs later next year as a possible recession looms. This had caused market rates to fall and equity prices to rise from their June lows – 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 an interest rate level that keeps the economy on a leash. He also said there would be « very likely » difficulties in the labor market, which could mean an increase in the unemployment rate, ie millions of job losses.

“These are the unfortunate costs of reducing inflation. But a failure to restore price stability would bring much greater pain,” he said, saying letting inflation escalate would only cause further hardship in the future as the Fed would have to act. more aggressively.

« History shows that the wage costs of reducing inflation are likely to rise with a lag, » he said.

Many conference attendees, who had been hoping for a tough speech from Powell, were thrilled. At six pages, his speech was considerably shorter and more direct than remarks made there usually are. This gave markets little room to read anything unintended in his words. The Dow Jones Industrial Average and the S&P 500 stock index plunged after the speech.

« It was extremely disciplined, extremely tight. Just say ‘we’re on this path, we’re staying on this path’ and not overcommit or overpromise, » said Adam Posen, president of the Peterson Institute for International Economics.

Powell’s former colleague at the Fed, Randal Quarles, called it « exactly what was needed at the time. » He said the central bank likely needed to raise its main borrowing rate to nearly 4% – it currently sits between 2.25% and 2.5% – and « they are on track to achieve that ».

The economy is already slowing, although it still shows « strong underlying momentum », according to Powell.

As for inflation itself, there are some early signs that it is easing. The Personal Consumer Expenditure Index – the Fed’s favorite measure of inflation – showed that prices actually fell slightly from June to July, in part due to lower gasoline prices, according to the data released Friday. But they are still up 6.3% from the previous year.

“While the weaker inflation readings for July are welcome, the single-month improvement is well below what the committee will need to see before we are confident inflation is coming down,” Powell said. .

He handed the responsibility for tackling price spikes to the Fed, 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 what is seen here in the United States,” Powell said. “None of this diminishes the responsibility of the Federal Reserve to carry out the task assigned to us to achieve price stability. There is clearly work to be done to moderate demand to better align with the offer. We are committed to doing this work.