Powell Should Remain Cautious to Avoid Even More Economic Turmoil
/p
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pLast week the emNew York Time/ems a href=https://www.nytimes.com/2021/11/22/opinion/biden-powell-inflation-fed-economy.html target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.nytimes.com/2021/11/22/opinion/biden-powell-inflation-fed-economy.html aria-label=published an opinion piecepublished an opinion piece/anbsp;bynbsp;a href=https://www.aei.org/profile/michael-r-strain/ target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.aei.org/profile/michael-r-strain/ aria-label=AEI’s Michael StrainAEI’s Michael Strain/anbsp;titled “Powell Needs to Cool the Economy Now to Avoid Recession Later.” Reasonable people can disagree over such things and, well, we disagree./p
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aside class=aside--right aside--large aside
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pIf history is any guide, it is wishful thinking to assume that the Fed can precisely offset the recent CPI surge, much less closely counteract price increases in specific categories of goods, such as lumber, beef, and poultry. /p
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pStrain wants the Fed to get more aggressive “immediately,” and that is opposite the approach thatnbsp;a href=https://www.cato.org/blog/inflation-brief-look-back-path-forward target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.cato.org/blog/inflation-brief-look-back-path-forward aria-label=I’ve been promoting for monthsI’ve been promoting for months/a. Aggressively tightening right now ignores that supply problems are anbsp;a href=https://www.cato.org/blog/inflation-brief-look-back-path-forward target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.cato.org/blog/inflation-brief-look-back-path-forward aria-label=primary driver of the recent CPI surgeprimary driver of the recent CPI surge/a. Tighter monetary policy in the face of those supply shocks means that people will have even less funds to purchase even scarcer goods./p
pThat’s anbsp;recipe for disaster, but Strain makes no mention of this problem./p
pYes,nbsp;a href=https://www.cato.org/blog/inflation-brief-look-back-path-forward target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.cato.org/blog/inflation-brief-look-back-path-forward aria-label=a good caseanbsp;good case/anbsp;can be made that the Fed should startnbsp;emsignaling/emnbsp;that it will soon tighten. And I’ve even made the case that the Fed shouldnbsp;emmildly/emnbsp;tighten in late 2021 or early 2022nbsp;emprovided that/emnbsp;nominal GDP (NGDP) stays on its current path. (It is basicallynbsp;a href=https://www.cato.org/blog/inflation-brief-look-back-path-forward target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.cato.org/blog/inflation-brief-look-back-path-forward aria-label=back to its pre-pandemic trendback to its pre‐pandemic trend/anbsp;now and seems to be increasing.)/p
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pBut assuming the Fed can aggressively tighten now without causing major economic problems, resulting in nothing more than staving off some future recession, gives the Fed much too much credit. This idea harkens back to the days when a href=https://www.latimes.com/archives/la-xpm-1987-06-17-mn-4589-story.html target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.latimes.com/archives/la-xpm-1987-06-17-mn-4589-story.html aria-label=federal bureaucrats naivelyfederal bureaucrats naively/a a href=https://millercenter.org/president/kennedy/domestic-affairs target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://millercenter.org/president/kennedy/domestic-affairs aria-label=believed that they could “fine tune” the economybelieved that they could ldquo;fine tunerdquo; the economy/a a href=https://www.jstor.org/stable/2977465?seq=1#metadata_info_tab_contents target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.jstor.org/stable/2977465?seq=1#metadata_info_tab_contents aria-label=to achieve permanentlyto achieve permanently/a high employment, stable prices, higher productivity, and better living standards. (Some people a href=https://www.fraserinstitute.org/studies/primer-on-modern-monetary-theory target=_blank title=https://www.fraserinstitute.org/studies/primer-on-modern-monetary-theory rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.fraserinstitute.org/studies/primer-on-modern-monetary-theory aria-label=might be holding on to that dreammight be holding on to that dream/a, but the rest of us are living in reality.)/p
pGiven that a href=https://www.cato.org/blog/inflation-brief-look-back-path-forward target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.cato.org/blog/inflation-brief-look-back-path-forward aria-label=poor fiscal andpoor fiscal and/a a href=https://www.cato.org/blog/more-regulation-will-not-improve-port-efficiency?utm_campaign=Cato%20at%20Liberty%20Newsletteramp;utm_medium=emailamp;_hsmi=183733527amp;_hsenc=p2ANqtz-9rO-hZ2d3Mq4BaOuApHOeP_VFt0Sr6tKbNFKGX-YpJNT2utFl4RfsQLPDmfz7ceIMTWMTTwydfqmTleTYgqXYiWAcqagamp;utm_content=183733527amp;utm_source=hs_email target=_blank title=https://www.cato.org/blog/more-regulation-will-not-improve-port-efficiency?utm_campaign=Cato%20at%20Liberty%20Newsletteramp;utm_medium=emailamp;_hsmi=183733527amp;_hsenc=p2ANqtz-9rO-hZ2d3Mq4BaOuApHOeP_VFt0Sr6tKbNFKGX-YpJNT2utFl4RfsQLPDmfz7ceIMTWMTTwydfqmTleTYgqXYiWAcqagamp;utm_content=183733527amp;utm_source=hs_email rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.cato.org/blog/more-regulation-will-not-improve-port-efficiency?utm_campaign=Cato%20at%20Liberty%20Newsletteramp;utm_medium=emailamp;_hsmi=183733527amp;_hsenc=p2ANqtz-9rO-hZ2d3Mq4BaOuApHOeP_VFt0Sr6tKbNFKGX-YpJNT2utFl4RfsQLPDmfz7ceIMTWMTTwydfqmTleTYgqXYiWAcqagamp;utm_content=183733527amp;utm_source=hs_email aria-label=regulatory policiesregulatory policies/a are undeniably increasing inflationary pressures (and contributing to a href=https://www.heritage.org/jobs-and-labor/report/excessive-pandemic-unemployment-benefits-are-warning-against-unemployment target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.heritage.org/jobs-and-labor/report/excessive-pandemic-unemployment-benefits-are-warning-against-unemployment aria-label=people staying out of the labor forcepeople staying out of the labor force/a), Strainrsquo;s proposal amounts to calling for dueling economic policies at the federal level. Against a backdrop of Congress and the administration a href=https://www.wsj.com/articles/biden-joins-the-lumber-wars-commerce-department-tariffs-canada-11638226400 target=_blank title=https://www.wsj.com/articles/biden-joins-the-lumber-wars-commerce-department-tariffs-canada-11638226400 rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.wsj.com/articles/biden-joins-the-lumber-wars-commerce-department-tariffs-canada-11638226400 aria-label=implementing harmfulimplementing harmful/a a href=https://www.heritage.org/monetary-policy/report/many-consumer-prices-are-higher-time-eliminate-government-imposed-economic target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.heritage.org/monetary-policy/report/many-consumer-prices-are-higher-time-eliminate-government-imposed-economic aria-label=policies that cause specific prices to risepolicies that cause specific prices to rise/a, he wants the Fed to use tight monetary policy so that the overall price level falls./p
pThe folly in this approach is evident in multiple segments of the economy, including housing. For instance, Strain wants the Fed to stop purchasing Fannie/Freddie mortgage-backed securities, a very sensible idea that would relieve at least some price pressure in the ldquo;a href=https://www.nytimes.com/2021/11/22/opinion/biden-powell-inflation-fed-economy.html target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.nytimes.com/2021/11/22/opinion/biden-powell-inflation-fed-economy.html aria-label=white-hot housing marketwhite-hot housing market/a.rdquo; But even if the Fed did stop buying those securities, the price pressures would move in the opposite direction as those from the Biden administrationrsquo;s policy to a href=https://www.nationalreview.com/2021/11/enjoying-autarky/ target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.nationalreview.com/2021/11/enjoying-autarky/ aria-label=double a punitive sales taxdouble a punitive sales tax/a on U.S. buyers of Canadian lumber./p
pBesides, if history is any guide, it is wishful thinking to assume that the Fed can precisely offset the recent CPI surge, much less closely counteract price increases in specific categories of goods, such as lumber, beef, and poultry. (Donrsquo;t forget that the Fed spent a href=https://www.heritage.org/monetary-policy/report/inflation-and-the-fed-how-congress-should-approach-monetary-policy target=_blank title=https://www.heritage.org/monetary-policy/report/inflation-and-the-fed-how-congress-should-approach-monetary-policy rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.heritage.org/monetary-policy/report/inflation-and-the-fed-how-congress-should-approach-monetary-policy aria-label=the last two decades consistentlythe last two decades consistently /aa href=https://www.heritage.org/monetary-policy/report/inflation-and-the-fed-how-congress-should-approach-monetary-policy target=_blank title=https://www.heritage.org/monetary-policy/report/inflation-and-the-fed-how-congress-should-approach-monetary-policy rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.heritage.org/monetary-policy/report/inflation-and-the-fed-how-congress-should-approach-monetary-policy aria-label=undershooting its inflation targetem data-ga-track=ExternalLink:https://www.heritage.org/monetary-policy/report/inflation-and-the-fed-how-congress-should-approach-monetary-policyundershooting/em its inflation target/a, even when there wasnrsquo;t any sort of economic turmoil.)/p
pThere are also at least three big-picture problems that a href=https://www.nytimes.com/2021/11/22/opinion/biden-powell-inflation-fed-economy.html target=_blank title=https://www.nytimes.com/2021/11/22/opinion/biden-powell-inflation-fed-economy.html rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.nytimes.com/2021/11/22/opinion/biden-powell-inflation-fed-economy.html aria-label=Strain’s policy recommendation shares with academic economicsStrainrsquo;s policy recommendation shares with academic economics/a:/p
ul
liIt credits the Fed with keeping interest rates low, thereby ldquo;running the economy so hot.rdquo;/li
liIt calls for the Fed to weigh price stability against maximum employment./li
liIt assumes that the Fed emshould/em pursue price stability./li
/ul
pFirst, Fed officials cannot simply make interest rates a href=https://www.heritage.org/report/fascination-interest-rates-hides-the-feds-policy-blunders target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.heritage.org/report/fascination-interest-rates-hides-the-feds-policy-blunders aria-label=whatever they desire them to bewhatever they desire them to be/a. In fact, it should be uncontroversial that the Fed cannot even maintain any (for example) federal funds rate it desires, especially at a level inconsistent with the underlying equilibrium (natural) federal funds rate. If, for instance, the Fed tries to maintain an unnaturally high federal funds rate (a rate above the natural rate), it will lead to excessively tight monetary policy. All else constant, lending, overall spending, and the price level, will fall, and the drop in the demand for credit will lead to a lower federal funds rate./p
pSecond, even though the Fed has a a href=https://www.heritage.org/monetary-policy/report/give-the-fed-single-mandate-monetary-neutrality target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.heritage.org/monetary-policy/report/give-the-fed-single-mandate-monetary-neutrality aria-label=congressional mandate that requires it tocongressional mandate that requires it to/a ldquo;promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates,rdquo; it largely pays lip service to the employment portion of the directive because it has to. Officially, the Fed a href=https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm aria-label=acknowledges thatacknowledges that/a ldquo;the maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market.rdquo;/p
pFinally, despite its mandate to promote price stability, it would be far better if a href=https://www.heritage.org/monetary-policy/report/give-the-fed-single-mandate-monetary-neutrality target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.heritage.org/monetary-policy/report/give-the-fed-single-mandate-monetary-neutrality aria-label=the Fed targeted total nominal spending growththe Fed targeted total nominal spending growth /aa href=https://www.heritage.org/monetary-policy/report/give-the-fed-single-mandate-monetary-neutrality target=_blank title=https://www.heritage.org/monetary-policy/report/give-the-fed-single-mandate-monetary-neutrality rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.heritage.org/monetary-policy/report/give-the-fed-single-mandate-monetary-neutrality aria-label=instead of inflationem data-ga-track=ExternalLink:https://www.heritage.org/monetary-policy/report/give-the-fed-single-mandate-monetary-neutralityinstead/em of inflation/a, thus striving to maintain a neutral monetary policy. In the face of supply-driven changes in the economy, an inflation-targeting central bank always pushes against the natural market forces that drive price changes./p
ul
liWhen there is a positive supply shock, such as an increase in productivity, prices should fall, thus allowing people to enjoy the benefits of more goods for sale at lower prices. This kind of deflation is a href=https://www.heritage.org/monetary-policy/report/give-the-fed-single-mandate-monetary-neutrality target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.heritage.org/monetary-policy/report/give-the-fed-single-mandate-monetary-neutrality aria-label=not the enemynot the enemy/a, and a growing economy does not automatically result in rising prices. Yet, the inflation-targeting central bank tries to raise prices./li
liIn the face of a negative supply shock, such as a major slowdown in trade, prices should rise as goods and services become scarcer. These price increases signal to businesses to supply more goods and services. Tighter monetary policy might lower the overall rate of inflation, but it will not result in more plentiful goods and services. It might even lead to more severe shortages. Yet, the inflation-targeting central bank tries to lower prices./li
/ul
pSound economic policy requires that any obstacles driving specific prices higher should be addressed directly. Sound monetary policy dictates that the Fed should tolerate a higher price level emprovided/em that the rate of inflation does not continue to climb and push NGDP too far. In the current economy, that policy prescription equates to (1) making sure that NGDP does not get too far above its pre-pandemic trend; and, (2) removing the policy barriers that are exacerbating the COVID-19 supply shocks, a href=https://www.cato.org/blog/more-regulation-will-not-improve-port-efficiency target=_blank rel=nofollow noopener noreferrer data-ga-track=ExternalLink:https://www.cato.org/blog/more-regulation-will-not-improve-port-efficiency aria-label=including restrictive labor, immigration, and trade policiesincluding restrictive labor, immigration, and trade policies/a./p
pStrain is right that ldquo;Mr. Powell faces a very different economy now than he did when he assumed leadership of the Fed in 2018.rdquo; There is, therefore, good reason to believe that tightening or loosening monetary policy to stabilize pricesmdash;the same basic policy prescription that wersquo;ve heard for the last half centurymdash;might not be the right approach./p
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