BUSINESS TIMES
https://www.businesstimes.com.sg/opinion/a-backlash-against-the-fed
A backlash against the Fed?
If the problem earlier was that Jerome Powell had been too much of an inflation dove, his becoming an aggressive inflation hawk now may pose new challenges for Americans.
TUE, NOV 01, 2022
THE conventional political wisdom on the eve of the midterm elections has been that the rise of pump prices, aka inflation, remains the top concern of the American voter, and would probably determine the outcome of the races across the country.
Indeed, according to the Pew Research Centre, four-fifths of Americans say that the economy will be “very important” when they vote in the midterms, while three-quarters of likely voters say they are “very concerned” about the rising prices of food and other goods.
Annual inflation is now running over 8 per cent, a 40-year high, and most voters blame the political party in power in the White House and Congress for it, and are therefore expected to punish the Democrats and President Joe Biden on November 8.
Hence the reference to the surge in inflation as “Bidenflation”, a term that the Republicans have been employing against the Democrats during the election campaign. After all, how many voters are familiar with the workings of the main driver of monetary policy, the Federal Reserve, or can even name the head of the US central bank, Jerome Powell?
It’s true that many economists, including Lawrence Summers, who had served in several Democratic administrations, agree with the following: That the expensive fiscal policies embraced by President Biden and his predecessor – who had signed on two huge stimulus plans in response to the Covid-19 pandemic, that amounted to about US$5 trillion and that was funnelled to households, businesses and local governments – have helped fuel the rise in prices and added probably close to 2 percentage points to the inflation rate.
It’s fair to argue that by the time President Biden entered office, with signs of post-pandemic economic recovery on the horizon, his administration shouldn’t have injected more money into the economy and in the process increased the demand for goods and as a result, the inflation rate.
But most economists, including Summers, also insisted that by continuing to pursue loose monetary policies despite clear indications that prices were surging, and in not responding immediately to the threat, the Fed was responsible for turning inflation from a manageable problem into a major economic crisis.
Powell has been criticised for his earlier dismissal of inflation as “transitory”, a threat that was likely to “wane”, even as it proved higher and far more persistent than he and the Fed’s economists had foreseen.
But let’s be fair to Powell and see what we now recognise as mistakes in the context of the time : Except for the warnings by a few economists like Summers, and against the backdrop of the pandemic, the lockdowns, rising unemployment and collapsing businesses, the Fed’s policies of injecting trillions of US dollars into the economy were welcomed by most Republicans and Democrats on Capitol Hill and the public.
After all, how many Americans were complaining after receiving their federal government cheques? Then they applauded the financial assistance that helped their families survive the lockdowns. It may be difficult for them to understand that these same policies that were responsible for the government subsidies that saved their small businesses, also helped ignite inflation by raising consumer demand to the stratosphere, which then overwhelmed global supply chains.
That may explain why politicians who only two years ago were praising the Fed’s monetary policies for helping Americans survive the pandemic are now blaming Powell and his colleagues for the high prices that are hurting the same Americans.
Powell has made it clear that the Fed was responding to this criticism by reversing course. He announced an unusual last-minute switch to a bigger interest rate hike, engineering a 0.75-point increase in the Fed’s short-term interest rate in June, the largest single rate rise in a quarter-century.
The Federal Open Market Committee (FOMC) repeated that extraordinary move in its next two meetings and is expected to implement a fourth whopping rate rise this week, only a few days before the midterm election, which would certainly come as bad news for the White House and the Democrats.
In fact, it should probably come as bad news to many Americans who may end up paying the costs, if the Fed’s new jumbo restrictive policies usher in an economic contraction that could lead to a severe recession and major job losses, as some critics are contending.
The Fed’s hike has already made it more expensive for many consumers and businesses to borrow. Housing prices are beginning to be hit in some major markets following the rise in mortgage rates, which means that the value of homes is falling (although it could also mean that more consumers would be able to afford to buy a house). And that, in addition to the downward effect the Fed’s steps have had on the stock market and on the value of the retirement funds of many middle class Americans.
In a way, it could be argued that through large interest rate hikes and the shrinking of its close to US$9 trillion balance sheet, the Fed is now overreacting to the inflation fears and overcompensating for having been “behind the curve” earlier.
Fed officials insist that Powell’s goal is to quell any lingering market doubts about the US central bank’s commitment to fighting the worst inflation outbreak in four decades. He made that clear during an address in August when he vowed that the Fed would “keep at it” until prices started going down.
But then if the problem earlier was that Powell was too much of an inflation dove, turning into an aggressive inflation hawk may pose new challenges.
More specifically, much of the focus has been on the headline inflation of 8.3 per cent which has been pushed up by rising food and energy prices that reflect temporary pressures. Those include the disruptions stemming from the war in Ukraine and the embargoes against Russia as well as from the pandemic-related actions and developments, from lockdowns to supply chain jams.
That suggests that the current inflation may be at least, in part, transitional: Many of these price pressures cannot be contained through interest rate hikes but can nevertheless be controlled as the effects of the pandemic and government spending sprees wind down and the war in Ukraine abates.
There are already some signs that consumer demand is weakening and business activity is slowing, suggesting that inflation has peaked, and that the main threat now is that of a recession that could ensue especially if the Fed continues to squeeze the economy, which it vowed to do if inflation doesn’t fall to its 2 per cent target.
A major rise in unemployment is almost certainly going to trigger a backlash from Democrats in Congress and labour unions and perhaps also from the White House that, until recently, has refrained from commenting on the Fed’s actions.
Even more interesting would be to see the response from the Republicans who have traditionally been regarded as inflation hawks but are now coming under the influence of the party’s populist wing that is supposed to represent the interests of members of the working class, who will be the main victims of an economic recession.