Date: 2024-07-17 Page is: DBtxt003.php txt00021632
FEDERAL RESERVE
ADDRESSING INFLATION
Get used to the Powell Ratchet
ADDRESSING INFLATION
Get used to the Powell Ratchet
Illustration: Shoshana Gordon/Axios
Original article: https://www.axios.com/powell-ratchet-65cdd2b3-9c9b-4379-acff-ae0730aefa8e.html
Burgess COMMENTARY
My impression is that the media has latched on to a rather simple economic issue and are running with it as fast as they can. The issue is, of course, inflation.
Nothing in economics is ever universally simple. Yet the media is completely incapable of reporting on anything unless it has been simplified and will fit a short sound byte. Simplified inflation is perfectly adopted for misinformation and twisting a story to fit a pre-existing set of talking points.
Parts of the media that want to put down everything associated with the Biden administration can find aspects of inflation that suggest that the Biden economy is a disaster and getting worse because of all the policy options that Biden has chosen.
Other parts of the media use aspects of inflation to show that the Biden administration has engineered a strong economy with important progress for working people.
Both are almost true and neither is complete.
My own take on the state of the economy is that in spite of the impact of the COVID-91 pandemic, the US economy in aggregate is surprisingly strong. The Federal Reserve helped with this in March of 2020 when it enabled a big round of quantitative easing (QE) and many other measures were put in place on an emergency basis by the Trump administration to help both people and business stay afloat in spite of major disruption to business as usual. Biden has done an impressive job with getting people to be vaccinated, building on the Trump success in getting vaccines developed, approved for use and into production. Biden has been faced with a huge amount of mainly GOP driven anti-vax hysteria, but in spite of this the vaccine program has been a pretty good success.
The supply chain chaos in recent months was not caused by political failures, but by business making all sorts of wrong decisions. The supply chain has been optimized over the years to be very efficient with lowest possible costs and highest possible revenues. This has been achieved by eliminating resilience ... the ability to change anything without it rippling around the total logistics ecosystem. The simple economic relationship between supply and demand that was descibed by Adam Smith in the early days of modern economics still applies and the business community chose to increase prices when shortages caused by the slowing down of the supply chain and increased demand from customers who had to change buying patterns as a result of all sorts of pandemic related changes in allowable behavior. Bottom line, most of the inflation is an inflation in profit ... it is demand-pull driven inflation, more than it is cost-push inflation.
One of the products that has increased in price substantially in the last few weeks is gasoline. In the 1970s after the OPEC oil shock of 1973 the cost of oil went from $3.50 a barrel to $13.50 a barrel. By the end of the decade the price had soared to more than $30.00 a barrel. This price was not controlled by the USA or the international oil industry but by the OPEC cartel of oil exporting countries headed by Saudi Arabia. Production costs for American businesses, transport costs for everyone and heating costs for buildings were all impacted by the increases in the price of petroleum. This was a cost-push problem and the only thing that could return the economy to sustainable profit margins was to increase prices. This took time and profits took an enormous hit.
Profits in the USA started to recover in the 1990s, but the US society took an enormous hit. There was a massive move towards outsourcing production to low wage areas of the world with China and other Asian countries the main beneficiaries. Productivity and profits have risen year over year for more than 40 years, but American wages have stagnated for this same period of time.
The current inflation and tight labor market in the USA may possibly change the business calculus.
My position is that this will certainly happen if the business world uses performance metrics that embrace the social, the environmental and the economic impacts of every activity and actor rather than just the profit performance of business and the aggregate size (GDP) of the economy. This is what TrueValueMetrics is all about.
Peter Burgess
Written by Neil Irwin
Updated Feb 3, 2022
The Federal Reserve's central dilemma in 2022 is this: Inflation is very high. Unemployment is very low. Yet monetary policy is currently set as if the reverse were true.
If the Fed readjusts policy to fit economic conditions too rapidly, it could cause a recession and/or financial panic. So instead, they're applying a strategy you can think of as the Powell Ratchet.
Chair Jerome Powell and his colleagues appear set to keep pushing toward tighter money, pausing along the way to make sure that they haven't overtightened and put the expansion at risk. Why it matters: This means a different market environment from the last two economic cycles, with extreme uncertainty around how high rates will get and how long it will take to get there. That could fuel more volatility on Wall Street.
More so than usual, the mystery is how long economic and market conditions will continue to allow them to carry out the policy ratchet. That helps explain why there is such a wide range of forecasts among reputable Fed watchers right now. Barclays economists are forecasting three rate increases this year, vs. seven rate hikes projected by Bank of America.
What they're saying: 'Every time the market gets comfortable with a new level of hawkishness, the Fed pushes it up a notch,' said Tim Duy with SGH Macro. 'They are turning up the heat gradually so they don't shock the markets.'
He believes the central bank is aiming to get the federal funds rate, now near zero, close to or even above the 'neutral rate,' which neither stimulates nor slows the economy. Fed leaders think it's around 2.5%.
That would imply 9 or 10 rate increases, assuming each was a quarter percentage point, significantly more than markets are pricing in. Between the lines: Comments from several Fed officials this week indicate that they are inclined to raise rates only 0.25% at a time, for now at least, which is consistent with the concept of the Powell Ratchet.
The goal is to push rates steadily higher to the degree economic conditions allow, not to shock and awe. The whole point is to adjust the stance of monetary policy in ways that the system can absorb.
In Powell's news conference last week, he made several comments supporting the idea that this will be a different type of tightening cycle.
'It isn't possible to sit here today and tell you with any confidence what the precise path will be,' Powell said. 'But as we work our way through this meeting by meeting, we are aware that this is a very different expansion… and I think those differences are likely to be reflected in the policy that we implement.' What would end the ratchet? Some possibilities:
Inflation finally comes down to earth. If there is clear evidence inflation trends are abating and settling down toward the Fed's 2% target, so would the upward pressure on rates.
The expansion sputters. If we see real-time measures of the economy turn negative in ways that don't look like an artifact of odd seasonal or pandemic-related quirks, Fed leaders would at a minimum slow their roll.
Financial panic arrives. It would likely take more than a mere stock market correction to get the Fed's attention, but if credit markets start to seize up that's a different story.
The bottom line: So far, Powell has been able to ratchet rate expectations higher without much apparent damage. There is no guarantee that will last.