Jerome Powell took three lessons from past inflations:
“The first lesson is that central banks can and should take responsibility for delivering low and stable inflation.” Powell acknowledged global inflation and supply problems, but said, “There is clearly a job to do in moderating demand to better align with supply. We are committed to doing that job.”
Second, he emphasized the role of public expectations about inflation in affecting inflation, sort of a “if you expect it, it will come” conclusion. That gave him a goal. He quoted Alan Greenspan: “For all practical purposes, price stability means that expected changes in the average price level are small enough and gradual enough that they do not materially enter business and household financial decisions.”
Third, “History shows that the employment costs of bringing down inflation are likely to increase with delay ….” He also said, “The historical record cautions strongly against prematurely loosening policy.”
I have been critical of the Fed, writing in August 2020 that the Fed’s new strategy would lead to higher inflation. In February 2021 I wrote that actual inflation statistics were low, but I was expecting a major increase. In May 2021 I wrote that the Fed did not understand what was driving the then-small increases in inflation.
That was then. Now the Fed gets it. Powell was late figuring it out, but now he gets it.
This means the Fed will keep tightening, and they will not falter a year from now when the job market worsens. It takes longer to bring down inflation than employment, which means a period of stagflation. The Fed, I believe, will stick to their guns. That raises the risk of recession in late 2023/early 2024, but it certainly is good for the long-term prospects for the economy.
Speech presented August 26, 2022.