Jay Powell this month stressed the Fed’s determination to fight the sluggish inflation numbers dogging the US economy, warning Congress that downbeat prices could lead to an “unhealthy dynamic” of lower interest rates and less room to act in a downturn.
“We’ve seen it in Japan. We’re now seeing it in Europe,” Mr Powell said in his testimony. “And that’s why we think it’s so important that we defend our 2 per cent inflation goal here in the United States and we’re committed to doing that”.
The 66-year-old former investment banker and private equity executive who took the helm of the Fed last year, is poised — as early as next week — to steer the US central bank towards its first interest rate cut since the financial crisis.
Mr Powell and other Fed officials have justified the need for looser monetary policy by citing “uncertainties” in the outlook due to trade tensions and a weaker global economy. But the persistence of low inflation in the US economy despite high growth and plentiful jobs, is a dominating factor behind the probable decision to cut rates by 25 basis points.
The Fed’s preferred measure of inflation — the core PCE price index, which excludes food and energy — is running at 1.7 per cent year-on-year compared with the central bank’s target of 2 per cent — and inflation expectations have also weakened.
“Powell is looking at the bigger picture: even with tariffs, with full employment, with fiscal stimulus, with all of these factors that generally should be inflationary, we still can’t get to target, at this stage of the cycle, in the longest expansion on record,” says Laura Rosner, senior economist at MacroPolicy Perspectives in New York. “If we’re not going to get there now, when are we going to get there? And there’s a good chance we could move lower, if there’s a wobble in the economy,” she added.
The US central bank’s mounting preoccupation with lacklustre prices was reinforced last week by John Williams, the president of the New York Fed, who gave a speech in which he called for “swift action when faced with adverse conditions” and to “keep interest rates lower for longer”. The New York Fed later issued a statement saying Mr Williams’ remarks should be viewed as an account of his research going back two decades, rather than a guide to future policy. But Mr Williams’ conclusion was clear: monetary policymakers needed to “vaccinate the economy and protect it from the more insidious disease of too low inflation”.
Some economists believe that the Fed may be overreacting, and below-target inflation — at least in the US — may be transient. While core PCE inflation is still below the 2 per cent target, it did edge up slightly in June, while the core consumer price index is running at 2.1 per cent. Jan Hatzius, chief economist at Goldman Sachs, says the US is “not far away” from its goal.” It doesn’t seem urgent to try to ease in order to get there,” he added.
One danger for the Fed is that an interest-rate cut fails to have the desired effect of stoking inflation, leading it to burn through monetary policy space without any substantial results to show for it.
Yet despite doubts about both the need and the effectiveness of easing, Mr Powell appears to have rallied the Fed around a consensus that the problem of tame inflation has become unsustainable and the central bank has the tools to tackle it. At last month’s policy meeting, Mr Powell faced a dovish dissent from James Bullard, the head of the Saint Louis Fed, who wanted immediate rate cuts, but there have been scant signs of hawkish opposition from officials who believe the Fed is making a big mistake. “Some people are not sold on it, but they are not on the barricades,” Mr Hatzius said. He noted that one effect of the prolonged period of low inflation since the financial crisis within the Fed was the evaporation of the concern that cutting rates would trigger an uncontrollable spike in prices.
As the Fed has turned to focus more on low inflation, so has a debate intensified on its causes. Some economists have stressed global disinflationary pressures and their spillovers, including the impact of technology, globalisation, and the rise of the “gig” economy, while others point to domestic factors such as weak price rises in healthcare and housing, which account for big parts of inflation indices and have offset the impact of Donald Trump’s tariffs over the past year.
Meanwhile, some basic economic mantras have fallen by the wayside, including the notion embedded in the so-called “Phillips Curve” that plentiful employment would lead to higher prices. “The relationship between the slack in the economy or unemployment and inflation was a strong one 50 years ago . . . and has gone away,” Mr Powell told Congress this month, adding there was no evidence of a “hot labour market” at this point.
“Wages have been climbing higher, but much slower than what you would expect,” said Beth Ann Bovino, US economist at S&P Global Ratings.
In an interview with CNBC this week, Charles Evans, the president of the Chicago Fed, outlined the likely debate that would occur at the next meeting of policymakers. While some like himself saw the argument for cutting by as much as 50 basis points to tackle the inflation problem, others might want to move more slowly. Regardless, sluggish prices have moved to the heart of the policy debate at the US central bank, at a critical juncture, amid growing concern that it they could increasingly be a constraint on the Fed, especially if a crisis hits.
“I don’t think it’s as much about “let’s generate inflation now”, it’s about defending the level of inflation you have,” said Ms Rosner.