Powell well is stronger than ever
The profession of central banker has changed forever. This was evident from Jerome Powell’s explanation of the Federal Open Market Committee’s (FOMC) interest rate decision. It may be called the interest rate decision, but the Fed will keep interest rates close to zero until at least 2024. The policy rate is a formality these days. Each quarter, the Fed releases new expectations regarding the economy and inflation. These expectations have been revised upwards substantially. Whereas in December, the Fed was still expecting 4.2 percent economic growth in 2021, that figure is now 6.5 percent. In comparison, Premier Li Keqiang indicated last week that the Chinese economy will grow by 6 percent this year. That means that for the first time since 1976, the US economy is growing faster than the Chinese economy. Just a little too late for Trump. According to the Fed, core inflation will rise to 2.2 percent this year, which is above the Fed’s target. In December, it was still 1.8 percent. The Fed has adjusted its inflation target since September last year. The traditional 2 percent target has become a long-term objective. Now that inflation has been below 2 percent for a long time, it can also be above 2 percent for a longer period without the Fed intervening. The Fed will therefore continue to buy 120 billion dollars worth of bonds every month. This is indefinite until the goals of the policy are met. One of those goals is to aim for full employment. The Fed expects an unemployment rate of 4.5 percent at the end of this year, but sees no reason to raise interest rates there either. The concept of unemployment has been stretched considerably by looking more at the participation rate and unemployment among minorities. There is also a third objective and that is financial stability. Before the Great Financial Crisis, the Fed did not look at that, but last night Powell hammered home the importance of that. Financial stability means nothing more than that financial markets must not fall, otherwise, the Fed will be forced to intervene. The implicit Fed put is thus formalized and stronger than ever.
The reason there were many questions to Powell about financial stability was the increased interest rates on the bond market. Without committing to any particular interest rate level, Powell did indicate that the Fed will intervene if financial stability is threatened. At the end of last year, there was speculation that the Fed would not allow the bond market to rise too sharply and would even formally intervene using Yield Curve Control, a ceiling on interest rates. Informally, such a ceiling exists, and it is the dot plot. It is a collection of dots on the horizon where the individual members of the FOMC indicate where interest rates should be. In December, one of the 18 FOMC members still expected interest rates to rise in 2022; now there are four. Since the dot plot was introduced, this can be seen as an informal interest rate ceiling. What is remarkable about the latest FOMC outcome is that the US economy is growing by as much as 6.5 percent this year – the highest growth rate since 1984 – and that core inflation is above the 2 percent target, but that at the same time interest rates are lower than ever. And then the FOMC comes out with the decision that it will do nothing for the next three years.
There was a time when a central banker had to keep inflation low. That time is over. Inflation has to go up, and to such a level that we can put the threat of deflation behind us for good. Inflation is not a threat to a central banker, it is seen as the solution. With all these new goals, the question arises as to when central bankers will become politically responsible. Central bankers these days have the odds stacked against them when it comes to their independence. The politician Lagarde is now president of the ECB and former Fed chair Yellen is now finance minister. Central bankers now even have sustainable goals. For example, the ECB sees a major role for itself in the climate crisis and the energy transition. The Federal Reserve pursues an active minority policy in the labour market. Politicians are becoming increasingly dependent on the goodwill of central bankers because of rising debts. Keynes is back again. It was John F. Kennedy who, for the first time since the Second World War, used fiscal policy with the objective of stimulating demand so that there would be a good rate of employment. That was followed by a period of almost 20 years now known as the ‘Great Inflation’. Now, fiscal stimulus is back, but this year’s rising inflation is seen as a temporary phenomenon. Let us hope that Powell realizes that in politics, temporary is all too often seen as permanent.