Inflation: What Fed Needs to Do
Powell Hasn't Learned From Past Mistakes
Federal Reserve Chairman Jerome Powell made at least three policy errors in forecasting inflation that led him and the Federal Open Market Committee to implement measures that have contributed to the perpetuation of significant price rises.
Several times during 2020 - 2021, he repeated his assertion that inflation resulting from supply bottlenecks would be “transitory”, leading the Fed to more than double its balance sheet between the start of 2020 and 2022, and lowering interest rates to near zero. Even today, after an attempt at asset reduction — termed Quantitative Tightening — the balance sheet is about 75% larger that it was just before covid struck.
Such an expansionary policy accompanied a massive increase in fiscal spending to offset covid’s impact on the economy. Reason? The Chairman emphasized that he focused only on monetary policy and would not react to fiscal measures. So, in effect, he ignored the concomitant fiscal expansion!
Such an attitude does not boost the monetary independence of the central bank but, rather, pushes policy to the height of irresponsibility. Rather than concede the error, the Chairman referred to the staying power of inflation in 2021 as “unexpected”.
Second, at his press conference following the FOMC meeting in December 2023, Powell confidently predicted that inflation was declining to the Fed’s 2% target. He based his conclusion on the low monthly figures recorded during the final months of the year. Instead, the Chairman’s cheerleading led stocks to surge and put more money into consumer wallets. Inflation accelerated during the first half of 2024.
Third, Powell stated at his post-FOMC press conference last September that the central bank had shifted its focus from inflation, which was no longer a major issue in his opinion, to employment which needed the Fed’s help. The FOMC lowered the Federal Funds rate by a larger-than-expected 50 basis points just seven weeks before crucial Presidential elections as Powell continued to profess the political independence of the Fed.
The reduction in the rate in September, and a cumulative one percentage point cut by the end of 2024, were significant forces behind the pickup in the Consumer Price Index in January. Data released by the Bureau of Labor Statistics on Wednesday should not have come as the surprise that many news outlets said it was. Although the cost of apparel declined by 1.4% in January from December, for example, the price of used cars and trucks surged by 2.2%. Put differently, repeated signals from the central bank that it would keep cutting rates made consumers more inclined to spend, only difference being in the type of good or service the expenditure was directed at.
Details of inflation in consumer prices released Wednesday indicated that there was little room for the Fed to hide. All four inflation measurements — the headline figure on month-on-month and annual bases, and the core statistic on month-on-month and annual bases — showed acceleration in January from December, moving further away from the Fed’s 2% goal.
Would this still have been the case if interest rates had not been reduced during the final four months last year? Probably not, and the yield on 10-year Treasurys may well have been lower as investors applauded the Fed’s anti-inflationary stance.
The lesson for Powell and the FOMC if they care to pay attention — which they have not in the past — is two-fold.
First, of the twelve voting FOMC members only one has dissented in each of two recent meetings — Governor Michelle Bowman in September because she wanted the policy rate to be lowered by only 25bp instead of 50bp; and Beth Hammack, President of the Federal Reserve Bank of Cleveland, in December because she opposed yet another rate reduction without clear signs that inflation was stabilizing at a lower level.
I would like to see more dissents at the March 18 - 19 meeting from the ongoing cut-or-pause policy, with two or more voters suggesting that the Fed should still consider inflation to be the major problem for the central bank to address. Along with it, a move to raise interest rates.
Second, it would be very beneficial for both inflation mitigation and market support for the Chairman to indicate at his press conference on March 19 following the rate hike that the Committee had just decided on, that he and his colleagues stood ready to tighten policy further if necessary.
Should the FOMC and Powell follow up on both suggestions, we will move some distance toward Treasury Secretary Scott Bessent’s goal of lowering the yield on 10- year Treasurys and, at the same time, lower the fiscal deficit toward 3% of gross domestic product as he wants to do.
What is the probability that these policy steps will, in fact, be undertaken by the Fed next month? Zero!
Dr. Komal Sri-Kumar
President, Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
February 15, 2025
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Can anyone tell me if this can affect XAUUSD
Omg. Fomc paused. Do you advocate a hike? Monetary policy is iterative and frankly I believe it is too restrictive. But I don't think the Fomc did or said anything wrong this meeting. My criticism now is that they are too data dependent. It would be better if Powell came out now on the record that he thinks the Fed needs to lower rates very cautiously, at least if that is their outlook. That appears to be their stance but why not say so? And state that they plan on leaving monetary policy alone for now. I have to somewhat agree with you on the balance sheet. It was too big versus the economy. I thought QE was left on far too long after the pandemic. Once liquidity came back and the markets functioned it should have stopped quickly. Now QT has reached its sell by date. The Fed should just let the economy grow in nominal terms to right size the balance sheet when compared to the size of the economy. I thought this was the best approach to start with. Stop Qs. It is like being the sorcerer's apprentice. Use rates and regulation as your tools. QE/QT is too unreliable as a policy tool.