The Fed’s Postponed Pivot Comes at a Price

The Federal Reserve chair has finally completed his “dovish” pivot. Speaking in Jackson Hole, Wyoming, the site of an annual get-together of central bankers, Jerome Powell effectively put an end to the cycle of monetary austerity that started in March 2022. “The time has come” to cut the Fed’s benchmark interest rate as early as September, he proclaimed.

In his speech on Friday, Powell explicitly acknowledged what has come to be known as the “long transitory” view of inflation: it was the slow reversal of pandemic-induced distortions of supply and demand, in conjunction with war-related effects on energy- and commodity markets, that was chiefly responsible for bringing key consumer price growth indices and overall inflation back down to 2.9 percent on a year-on-year basis.

Raising the federal funds rate — the rate at which banks with interest-bearing reserve accounts at the Fed lend each other money (their excess reserve balances) overnight and which effects borrowing cost throughout the US and global economy — from 0.25% to a twenty-three-year high of 5.50% and maintaining it at that level for over a year had contributed to this disinflation by “moderating’” aggregate demand, Powell noted. But the labor market was no longer a “source of elevated inflationary pressures.”

Part of the problem is that the primary transmission mechanism at work in the “moderation” is frustratingly indirect: it involves weakening job and wage growth through tighter financial conditions for firms, which respond by reducing operational expenditures (mainly wages), in turn dampening household expenditure and thus overall demand. This is a painful, grinding process. Powell understands this perfectly well. At a previous installment of the Jackson Hole symposium, he had signaled his willingness to cause a recession and to “bring some pain” for households and firms.

Ultimately, this will do the job — in the same way a baby will…