The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and Gramercy
Over the years, the annual central bank confab at Jackson Hole has seen Federal Reserve chairs address immediate policy issues as well as longer-term and more academic ones, that involve the economic and institutional context for policymaking.
Present circumstances called for Jay Powell, the current chair, to do both — that is, address the policy errors of the last 18 months, try to realign monetary policy expectations and establish a path for the resetting of the guiding policy framework. In the event, his brief speech (just under nine minutes) last Friday largely attempted just one of these three. By focusing on the present, he left much still to be said while less than fully exploiting a much-anticipated opportunity for enhancing policy effectiveness.
There are five reasons why Powell needed to deal with issues that relate to the past, present and future. First, time has not been kind to his presentation at last year’s gathering. His characterisation of inflation as transitory, his forecasts of the economy and his elucidation of the required policy responses have fallen short. They are now part of the four-element Fed policy mistake that involves inadequate analysis, bad forecasts, poor communication and belated policy responses.
Second, Fed slippages have robbed the country (and, therefore, the global economy) of a first best policy response and the soft-landing that can come with that. If left uncorrected, this is a mistake that builds on itself, aggravating problems of low growth, high inflation, worsening inequality and future financial instability.
Third, markets went from following the central bank’s guidance to sidestepping it. Indeed, this may well be the least credible Fed in the markets’ estimation since the 1970s. Its quarterly forecasts have been repeatedly dismissed as fantasy and its communication is seen as lacking the consistency needed for effective policy guidance. This is a combination that slows the necessary evolution in the market mindset from a mainly cyclical view, including romanticising an early policy pivot towards lower rates, to a more structural one.
Fourth, the Fed is encumbered with a policy architecture — the “new policy framework” — that is not fit for purpose. Adopted two years ago, it was designed for the past world of insufficient aggregate demand. As a result it is somewhere between ineffective and counter-productive in the current and future world of challenged aggregate supply.
Finally, the Jackson Hole audience is dominated by economists, the majority of whom both understand the importance and urgency of a politically independent central bank, and worry about the path this Fed has been on.
In this context, Powell correctly opted for a notably hawkish tone. He rightly stated that “high inflation has continued to spread through the economy”, that “there is clearly a job to do” to bring inflation back into control, and that the Fed must “keep at it”. He also said this will entail “a sustained period of below-trend growth”. In the process, he attempted to clean up his July remarks that former US Treasury secretary Larry Summers characterised as “analytically indefensible” and “inexplicable”.
Illustrating a more general sensitivity to reputational risk, and the political vulnerability that comes with that, Powell combined this hawkish tone with reference to several of his predecessors. The attempt to borrow from past credibility included quoting Paul Volcker whose inflation-beating reputation is as strong today as it was in the 1980s.
Equally important is what Powell did not do. He is yet to take responsibility for the last 18 months of Fed errors, including the mis-characterisation of economic and policy issues in last year’s speech. He is also yet to provide a pathway for the much-needed revisions to the policy framework.
In a world of perfect foresight, Powell’s 2021 speech would have focused on monetary policy at a time of sudden high inflation and, this year, on restoring the central bank’s credibility and policy effectiveness in an even more challenging world of rapidly slowing global growth, worsening inequality and widespread high inflation. Instead, his unusually short speech essentially dealt well with the present, but left out important past and future issues.
I suspect that we will look back on this year’s Jackson Hole speech as a missed opportunity for the Fed to regain control over its policy narrative, as well as to outline what is needed to overcome the considerable policy challenge facing the world’s most powerful and systemically important central bank.