Jerome Powell’s choice: More misery or less misery

Let’s thank Federal Reserve Board Chair Jerome Powell for his gift last week. “The time for moderating the pace of rate increases may come as soon as the December meeting (scheduled for Dec. 13 and 14),” he announced. And though this means the Federal Reserve will increase interest rates by .50 percent, slightly smaller than the previous four consecutive increases of .75 percent each, it is nevertheless significant.

As with chemotherapy, the dose and frequency of rate hikes matter to avoid undesirable side effects. This smaller increase, and possibly others like it to follow, is bound to cause less misery among consumers and workers — and could help the U.S. avoid a hard economic landing.

Powell’s statement reflects not only a change in tone but a more confident chair who realized that a more moderate path to fighting escalating prices, now 7.7 percent annually, is a less risky strategy than his past actions. And while inflation will continue to be a challenge, possibly for a longer period than the Fed had originally anticipated, a moderate path would give Powell more time to adjust monetary policy to the lagged effects of previous rate increases, and to consumer spending, which could decline quickly once consumers’ exhaust their stimulus money.

A complicating factor in the Fed’s inflation fight is that a portion of the present inflation is caused by the high prices of food and energy brought about by the Ukraine war, prices that the Fed can hardly influence.   

According to the Bureau of Labor Statistics, energy and food constitute more than 21 percent of the products and services included in the Consumer Price Index. These categories comprise 1.65 percent of the annual inflation of 7.7 percent, and they cannot be readily controlled. As a result, the lowest inflation rate the Fed can hope for is 3.65 percent — that is, its 2.0 percent target rate plus 1.65 percent.

Until Powell’s statement last week, his model for fighting inflation had been that of Paul Volcker, the 1980s-era Federal Reserve Board chair who controlled runaway inflation of 14 percent in 1980 by increasing the Fed funds rate to 22 percent and driving the U.S. economy into recession. 

Powell must have realized that it was a bad idea for him to follow Volcker, because present U.S. inflation is different than the stagflation of the early ‘80s. Inflation now is 7.7 percent, much lower than what Volcker confronted, and unemployment is 3.7 percent, significantly lower than the 10.8 percent that Volcker faced.

Powell must also know that he has a history of making over- and under-reaching monetary policies. For example:

• In 2019, Powell began to tighten the Fed rate prematurely, recognized his mistake and reversed course.

• In spring 2020, facing a pandemic-induced economic collapse, he pumped trillions of dollars into the economy for far too long, held the Fed rate close to zero and propelled the present high inflation. 

• Earlier this year, Powell waited too long to tighten and until recently has been overreacting by moving rates higher and faster.

Powell’s choice this year has been clear, stark and difficult: Continue to fight inflation by increasing the funds rate by 75 points every time the Fed meets, thus ensuring recession, high unemployment and declining Gross National Product (GNP); or act with moderation by pausing rate hikes or increasing rates gradually, or both, thus skirting recession, causing less unemployment and less negative GNP growth.

Stated differently, Powell’s choice has been between more misery and less misery.  

Until last month, he chose a monetary policy that causes more misery. Now he seems poised to choose a monetary policy that causes less misery and could eventually bring about a soft landing, though the treatment may take longer. It takes a big man to realize his mistakes and adjust course.

Avraham Shama is the former dean of the College of Business at the University of Texas, The Pan-American. He is professor emeritus at the Anderson School of Management of the University of New Mexico. His book on stagflation was published by Praeger Publishing, and his new book, “Cyberwars: David Knight Goes to Moscow,” was recently published by 3rd Coast Books.