Federal Reserve Chairman Jerome Powell has finally, albeit belatedly, seen the light and admits the country has a real inflation problem. He has, however, yet to own up to the Fed’s role in creating that problem and another one: an equity, housing and credit-market bubble.
So he certainly won’t admit how difficult the Fed’s ultra-easy monetary policy has made it to slay the inflation dragon without precipitating a nasty economic recession.
After spending much of last year telling us that inflation would prove to be but a transitory phenomenon, Powell last week had the Fed increase its lending rate from zero bound to between 0.25 and 0.5%. Never mind that consumer price inflation has been running at almost 8%, a 40-year high. Never mind too that Russia’s Ukrainian invasion and China’s new COVID-induced lockdown of some major cities is sure to propel inflation even higher.
In a speech this week to the National Business Association, Powell acknowledged that the series of small interest-rate increases that the Fed is planning might fall short of what is required to quell inflation. Instead, he now envisions that starting at its next meeting, in May, the Fed might need to begin raising interest rates in 50 basis-point increments.
Powell was, however, careful not to assume any responsibility for the Fed’s role in driving inflation higher even before Russia invaded Ukraine. He didn’t explain, for example, why the Fed maintained a zero-interest-rate policy throughout the last year — or why it allowed the money supply to balloon at a time the economy was recovering strongly and receiving the largest peacetime budget stimulus on record.
The Fed chief also has yet to tell us why the bank continued to buy $120 billion a month in Treasury bonds and mortgage-backed securities when the equity and housing markets were on fire. That excessive liquidity injection has led to the unhealthy situation of equity valuations reaching nosebleed levels experienced only once before in the last 100 years and housing prices topping their 2006 level even in inflation-adjusted terms.
With inflation already running at its highest level since 1982, the last thing we need is another external inflation shock. Yet that’s what we’re about to get from the spike in international oil, food and metal prices as the direct result of Russia’s invasion of Ukraine. Over the past month, gasoline prices have jumped by more than 20%, to $4.30 a gallon. That alone must be expected to add close to 1 percentage point to our already sky-high inflation rate.
China’s lockdown of key cites in response to a renewed COVID outbreak might also further cloud our inflation outlook, by preventing any early repair of disrupted global supply chains and by adding to international shipping delays.
The upshot is that in no small measure due to its own recklessness last year, the Fed finds itself with only bad policy options.
It could do the right thing now by raising interest rates more aggressively, even though that might burst the equity- and housing-market bubbles and cause a recession. Or it could stick to its current path of modest rate hikes and fall further behind the inflation curve. But that would likely mean a much deeper recession in the end, since it would allow inflation to take hold and require even higher interest rates to get it back under control.
The Fed’s mess is all the more regrettable because the weakest parts of our society will be the hardest hit by a recession in much the same way they’re now the hardest hit by inflation.
Since the Fed is an unelected body, the public won’t even be able to derive some satisfaction from making it pay for its egregious policy mistakes that have played no small part in getting us into this economic mess.
Desmond Lachman is a senior fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.