Powell: ‘Overheated’ job market can withstand rate hikes

Federal Reserve Chair Jerome Powell expressed confidence Thursday the central bank would be able to hike interest rates to fight inflation without derailing a historically strong labor market.

In testimony Thursday before the Senate Banking Committee, Powell acknowledged the Fed misjudged how long inflation would rise, but said the bank could still bring it down without upending job gains.

Powell called the labor market “overheated,” pointing to record ratio of job openings for unemployed workers and a historic rate of workers quitting their current gigs for ones with better compensation, working conditions or opportunities. The unemployment rate held strong at 4 percent in January, but employers have struggled to fill open positions and keep up with rising wages, as millions of workers who left the job market in 2020 remain on the sidelines.

“We have substantial excess demand,” Powell said, referring to the steady growth in consumer spending above pre-pandemic levels, even as prices rose 7.5 percent annually in January, according to Labor Department data. 

“There’s a lot that we could do to gradually bring demand back down to where demand and supply are more in sync and without risking damage,” he said.

Powell’s comments come roughly two weeks before the Fed is expected to raise interest rates at the conclusion of its monetary policy meeting March 15-16. The meeting falls almost two years to the day the Fed slashed interest rates to near-zero levels and began purchasing trillions of dollars of bonds to stimulate the economy through the coronavirus recession.

Unprecedented stimulus from both the Fed and Congress helped fuel a rapid recovery from the downturn, but also boosted pressure on supply chains snarled by material and labor shortages, order backlogs, shutdowns and other pandemic-related obstacles. Inflation hit an annual rate of 6.1 percent in January, according to the Fed’s preferred gauge of price increases, more than three times its annual target of 2 percent.

Powell said he and other Fed officials believed pandemic-driven supply challenges would fade far sooner than they have, which prompted their patient approach to inflation as it rose steadily in 2021.

“What the textbook says is the shock is going to come and it’s going to go and and you shouldn’t react to it,” Powell said. “Hindsight says we should have moved earlier and that that turned out to be wrong.”

“It’s just taking so much longer for the supply side to heal than we thought,” he continued. “There really is no precedent for this.”

While Democratic senators shared Powell’s concerns about inflation, some expressed fears the Fed could upend the recovery as the economy faces new challenges related to the Russian invasion of Ukraine. Senators in both parties also cited challenges facing farmers from the dual threat of rising interest rates and threats to the global supply of fertilizer, much of which comes from Russia and Ukraine.

“Part of what’s happening in the economy is the relative power of employers versus workers is shifted so that workers have more power,” said Sen. Tina Smith (D-Minn.).

“Assuming the Fed does what it is planning on doing and raising interest rates, what impact does that have on the workforce shortage, if anything?”

Powell said raising rates will “slow economic activity gradually” by raising borrowing costs throughout the economy, which most consumers experience through higher rates for credit cards, auto loans and mortgages. Doing so, he explained, would bring consumer demand down to where it no longer forces suppliers to raise prices at such high rates.

Many Republican senators said it was long past time for the Fed to start bringing rates higher, and some questioned Powell’s commitment to cooling off inflation.

Sen. Richard Shelby (R-Ala.) invoked former Fed Chairman Paul Volcker, who spearheaded a battle against double-digit inflation with staggering interest rate hikes.

“So you’re willing to do whatever it takes to protect price stability?” Shelby asked.

“Yes,” Powell replied.

“Well, that’ll be a departure from what you’ve done,” the senator shot back.