The secret behind Federal Reserve Chairman Jerome Powell’s surprise U-turn on monetary policy can possibly be found in comments he made in New York a year and a half ago.
Asked how he’d respond to what was then a hypothetical scenario of below target price rises and low unemployment, Powell replied: “My own view would be that we have to be committed to our 2 percent inflation mandate and we’d need to conduct monetary policy in a way that supported inflation going up.”
And now it has — and Powell has reacted accordingly. In a move that caught investors off-guard, he signalled last week that the Fed is done raising interest rates for at least a while. The abrupt shift left economists wondering whether muted inflation pressures will keep Fed rates on hold into the second half of 2019, even if the crosscurrents of weaker global economic growth and tighter financial conditions buffeting the US subside before then.
“I would want to see a need for further rate increases and, for me, a big part of that would be inflation,’’ Powell told a January 30 press conference.
What’s unclear is how much — and how persistent — of an increase in inflation Powell would like to see. The Fed’s favourite inflation gauge rose 1.8 percent in November from a year earlier, down from 2.4 percent in July. Powell said it’s likely to fall further in coming months due to a drop in oil prices. “The increased emphasis on inflation has raised the bar, but not to the point of being a prerequisite’’ for another hike, probably in the second half of the year, Goldman Sachs Group Chief Economist Jan Hatzius said in an email.
It was Hatzius who asked then-Governor Powell at a 2017 Economic Club of New York meeting how he’d respond to a late 1990s style scenario of subdued inflation and low unemployment, noting that the Fed at the time plowed ahead with rate increases.
To be sure, there are differences between then and now. Core inflation averaged 1.4 percent in 1999 versus 1.9 percent now. And the stock market back then was in bubble territory.
Today’s heightened focus on fostering faster price increases comes as the Fed is about to launch a wide-ranging public review of its practices, including how best to achieve its inflation goal. Allianz SE chief economic adviser Mohamed El-Erian sees the Fed on hold for the entire year, restrained from raising rates by economic weakness overseas, the absence of an inflation threat and hesitation to re-ignite financial market volatility that followed its December hike.
That “gives investors more confidence to re-engage in the market,” the Bloomberg Opinion columnist said. Fed policy makers have been puzzled for a while about why inflation hasn’t risen given how far unemployment has fallen. Joblessness was 4 percent in January, below officials’ 4.4 percent median estimate in December of the non-inflationary natural level.