Powell’s monetary policy outlook reflects a Fed with few options

On Friday, June 16 the Fed released the semiannual monetary policy report to Congress. The report is inclusive of data available through 16:00 ET on June 14. As such it doesn’t include the May data on retail sales, jobless claims for the week ended June 10, the import and export price indexes, or the University of Michigan consumer sentiment index. Policymakers have access to the data on industrial production since that is produced by the Federal Reserve. These reports don’t really change the picture painted by the data which is one of a still tight labor market and inflation at the core which is mainly in non-housing services.

The monetary policy report serves as a template for the Fed Chair’s prepared remarks before each of the Congressional committees at which the semiannual monetary policy is delivered. For this round, summer testimony begins at 10:00 ET before the House Financial Services Committee and resumes at 10:00 ET before the Senate Banking Committee. Although not on the official schedule, it is typical for the Fed to release the prepared remarks at 8:30 ET when the House committee leads the rotation.

While the monetary policy is a product of the Board of Governors and issued by it, the contents will be heavily informed by the most recent FOMC meeting of June 13-14.

The central points of the summary in the report are two. First is, “Bringing inflation back to 2 percent will likely require a period of below trend growth and some softening of labor market conditions.” Second is, “The Federal Reserve is acutely aware that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials. The FOMC is strongly committed to returning inflation to its 2 percent objective.”

As was the case when Chair Jerome Powell delivered the February testimony, he is likely to get hammered on the potential for job losses in the millions if the FOMC persists in keeping monetary policy restrictive. After the upward revision in the FOMC median forecast for the fed funds target range by about 50 basis points for 2023, he will hear even more about the harm that higher rates does to individuals and businesses. The implication is that the Fed is callously endangering the livelihood of Americans by cutting off credit to individuals and businesses.

Powell will probably reply along the lines of what he said in February and has reiterated since as recently as his press briefing on June 14. He said, “Without price stability, the economy doesn’t work for anyone.” The Federal Reserve has essentially one tool to fight inflation: raising interest rates — to lower demand and cool the economy. To imply that the central bank should not use it to achieve its Congressional mandate of price stability is disingenuous at best. The Fed would fight inflation without job losses if it could, but its options are limited.

The Fed has more than enough evidence that the inflation cycle of the 1970’s and early 1980’s was difficult to end and require determined leadership on the part of then-Chair Paul Volcker to accomplish. Tentative monetary policy that tried to avoid unpopular rate hikes and elevated unemployment were unsuccessful. After the Volcker Fed “broke the back” of high inflation, a long period of relative price stability allowed the Fed to keep interest rates at modest levels for a long period. Powell and other Fed officials are almost certainly right to stay the course on tight monetary policy to keep inflation expectations in check and until inflation is tamed even if the lesson has been forgotten in the generation since the last major episode.