Nearly a year ago, when US Federal Reserve Chair Jerome Powell delivered his speech at the annual economic conference in Jackson Hole, a global audience was hanging on every word for insights into the outlook for growth, inflation and monetary policy in an extremely uncertain environment.
Given how mistaken his assessment proved to be, he’ll have a harder time sounding convincing when he gives his next speech in the same venue later this month. But for the sake of the Fed’s efforts to contain inflation, he’ll have to try.
In his 2021 address, Powell got it wrong in several important ways. He asserted that a nascent surge in inflation was “likely to prove temporary,” that the low unemployment rate “understates the amount of labor market slack,” and that “we see little evidence of wage increases that might threaten excessive inflation.” He endorsed the more inflation-tolerant monetary policy framework that the Fed adopted in 2020 as “well-suited to address today’s challenges.”
Powell surely hopes this year’s speech will prove more prescient. I expect him to emphasize three themes: that the economy still has forward momentum with an extremely tight labor market and unacceptably high inflation, that the Fed must tighten monetary policy further to restrain the economy and ease pressure on the labor market, and that the Fed won’t relent until it’s sure it has done enough for long enough to achieve its 2% inflation target.
In delivering this message, Powell must take care to disabuse markets of the notion that the Fed will soon be done tightening monetary policy. Many investors appear to have reached this conclusion based in part on Powell’s statement in July that future interest-rate increases will be data-dependent, ignoring his repeated reference to the Federal Open Market Committee’s interest rate projections indicating a peak considerably above what financial markets expected. The result has been a rally in stocks and bonds that is undermining the Fed’s inflation-fighting efforts.
Powell must make clear that even if the Fed pivots to smaller interest-rate increases in coming months, that does not necessarily indicate a lower peak. As the Fed closes the gap between where monetary policy was and where it needs to be, it may be able to move in a more measured way toward the same ultimate goal. From 2004 to 2006, for example, the central bank brought its interest-rate target from 1% to 5.25% in 17 consecutive 25-basis-point steps. The pace of tightening had little to do with where interest rates peaked.
To convince markets of the Fed’s resolve, Powell will have to be forceful. Many see his warning as mere rhetoric, designed to keep inflation expectations down. They think that once the economy slows, unemployment rises and inflation falls, the Fed will start cutting interest rates long before the 2% target has been achieved. Powell will need to find a way to persuade them that he has no intention of behaving like Arthur Burns (the Fed chair who relented prematurely in the 1970s), lest he later be forced to act like Paul Volcker — who had to correct Burns’s mistake by putting the economy through two recessions.
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