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Powell’s warning: ‘Surprises may be in store’ on inflation

Fuel prices have soared since Russia’s invasion of Ukraine, adding to inflation concerns that could lead to major electoral losses for Democrats this year. In a bid to address Americans’ anxiety, President Joe Biden has called for a three-month pause on the federal gas tax, despite it having almost no chance of passing Congress.

Powell said inflation wouldn’t be so high without strong demand for goods and services from U.S. consumers, but he also pointed out that global supply chains were still under strain, which the Fed is not responding to. does not have the tools to cope. And the spike in food prices “would certainly be much lower” without the war in Ukraine, he said.

Here are some other takeaways from Powell’s testimony:

The risk of overdoing it

Powell appeared before the committee a week after the Fed pulled the trigger on a three-quarters percentage point rate hike – the biggest increase in a single meeting in nearly 30 years.

Democrats on the panel expressed concern that the Fed was embarking on aggressive rate hikes to fight inflation which they say is primarily caused by supply chain issues and the war. They fear it will hurt the economy without helping prices much.

“Rate increases make it more likely that companies will lay off employees and cut work hours to cut payroll costs,” the senator said. Elizabeth Warren (D-Mass.) says. “Rate increases also make it more expensive for families to do things like borrow money to buy a home. Inflation is like a disease, and medications need to be tailored to the specific problem or you could make things worse. And right now, the Fed has no control over the main driver of rising prices.

Powell and other Fed officials have acknowledged that while some factors affecting inflation are beyond their control, they believe there is still plenty of room to slow purchases of goods and services — and by extension, the demand for workers – at a more sustainable rate.

“Clearly both factors are primarily at work here,” the Fed chief said. “You couldn’t get that kind of high inflation without strong demand, and you certainly couldn’t get it without the kind of supply issues we’ve had, both in the labor market reflected in high wages and in the goods market.”

Late to the party

Republicans have chastised Powell for only raising borrowing costs earlier this year, with some saying the central bank needs to go much further.

“While I’m glad you’ve started taking the drastic measures needed to fix the U.S. economy, those measures are long overdue and monetary policy remains too accommodative,” Sen said. Thomas Tillis (RN.C.), pointing to the 8.6% increase in prices over the past year.

Tillis revived a long-standing GOP talking point that the central bank should be bound by formalized rules in its interest rate decisions. He pointed to a formula, named after Stanford economist John Taylor, suggesting that the central bank’s key policy rate should be several times higher than it is.

“The Fed has largely locked itself into a menu of purely reactive policy measures,” he said. “Unless the Fed works quickly to move away from its discretion-based monetary policy approach that has consistently stayed well below the curve, I fear the Fed will lose credibility to effectively manage the national economic situation. .”

Is the labor market too hot?

The jobless rate is near modern lows at 3.6%, and there are more job openings than available workers, a condition that led Powell to call the job market “unsustainably hot.” Fewer people are participating in the labor force than before the pandemic, which has exacerbated labor shortages.

“We want people to get big pay rises, but at a certain point wages get high enough that companies start raising prices, and you end up having high inflation,” he said. . “It’s really not about cutting wages. It’s about having a more sustainable rate of increase.

Inflation has risen faster than average wages, meaning most workers are left with less money despite the increases.

Powell said wage increases for Americans are not yet a driver of inflation, but the Fed fears a scenario where incomes are pulled higher by inflation rather than higher productivity, which can then lead to an unhealthy feedback loop where prices and wages keep rising.

The risk is that “we allow this high inflation to take root in our economy,” he said. “We know from history that this will hurt the people we love to help, low income people who are currently suffering from high inflation. It would hurt them more than anyone. So we cannot fail in this task. We need to get back to 2% inflation so we can have the kind of labor market we really want. »

Watch house prices

The housing market is very sensitive to interest rate hikes, and Powell said he expects the Fed’s actions to be felt clearly by those looking to buy and sell real estate. As mortgage rates climbed to nearly 6%, housing demand began to slow, he said.

“That should have an effect on house prices, maybe even quite quickly, so that prices won’t necessarily go down, but price increases will level off,” he said.

For the Fed’s purposes, that will mean its policies are working as intended, but he acknowledged that it could also slow housing construction in a market that has long lacked sufficient supply. This could pose broader affordability issues that the central bank is not equipped to address.

“It is very possible that we are in a position where there is not enough suitable housing at the right price,” he said.

The economy is changing in mysterious ways

Powell pointed out that while the Fed expects to continue raising rates, the speed and level at which it does so will depend on how economic data evolves.

“Making appropriate monetary policy in this uncertain environment requires recognizing that the economy often moves in unexpected ways,” Powell said. “Inflation has obviously surprised on the upside over the past year, and more surprises may be in store. So we will need to be nimble in responding to incoming data and changing outlooks. And we will strive to avoid adding uncertainty to what is already an extraordinarily difficult and uncertain time.

Kate Davidson contributed to this report.