Eschewing the traditional subtlety and understatement characteristic of central bankers, US Federal Reserve chair Jerome Powell told Americans to prepare for a deliberately engineered recession in order to contain inflation, in comments that sent sharemarkets in Europe and the US plunging on Friday.
In comments at the Fed’s annual Jackson Hole symposium on Friday, Powell said higher unemployment and slower growth were prices worth paying. “While higher interest rates, slower growth and softer labour market conditions will bring down inflation, they will also bring some pain to households and businesses,” he said. “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
And he indicated there’ll be now early respite from rate rises: “Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.”
Powell’s comments place him firmly in the Fed tradition established by Paul Volcker, who chaired the Fed from 1979 to 1987, during which Volcker fought the inflation that plagued the US and global economies economy through the 1970s and into the early ’80s.
From August 1979 to April 1980, Volcker raised interest rates from around 11% to 17.5%. Inflation over this period rose from 11.8% to 14.5%. A pause in inflation pressures in the summer of 1980 prompted Volcker to make a key error and begin cutting rates — by July 1980, rates were below 9%. Inflation remained above 12%, so Volcker began another series of rate rises so that by the end of 1982 inflation had retreated back below 10% for the first time in three years.
Volcker didn’t repeat his mistake — US market rates wouldn’t fall back below 9% until December 1982 and wouldn’t fall back under 8% until 1985.
It’s a mistake Powell has indicated he will not be repeating, either. In fact, with unemployment in a far different position than back in Volcker’s time — it was 9% in 1982 — it can be argued that a longer and tighter monetary policy stance is justified.
Powell’s comments should kill off the optimistic view of some in financial markets that central banks will treat inflation as a passing problem and that interest rates will start coming down within 12 months. Powell’s previous comments had already indicated the Fed was committed to killing inflation and now he’s confirmed a “stronger for longer” approach — which is why sharemarkets tanked.
Even though a tough US monetary policy won’t necessarily lead to a slowdown or recession in Australia, it will have an impact and is a precursor of what could lie ahead for Australia in 2023. The one big difference with the US is that we have an extremely strong trade account driven by energy shortages and high prices for coal, oil and gas — and which will continue into 2023. That will provide a cushion if — or when — the Fed drives the US economy into recession and China continues to struggle to return to the strong rates of growth it was used to prior to the pandemic.
This week’s jobs summit will focus on the very un-1980s problems of labour shortages, wage stagnation and low immigration. But Powell’s comments suggest we haven’t escaped the preoccupations of 40 years ago, and could turn our problems from raising wages to saving jobs.
