Is Powell too late in declaring war against inflation?

WITH inflation skyrocketing 7.9 per cent over the past year, according to the February report from the US Bureau of Labor Statistics, the fastest rate of inflation since June, it is not surprising that all the major players in Washington are engaged now in the usual blame game.

The trick in this game is to ensure that the adjective that comes before the term "inflation" refers to your political rival, like "Biden Inflation" or #Bidenflation. That is exactly what the Republicans have been doing in recent months, hoping that voters would blame the president and his Democratic Party for the rising petrol and food prices, and punish them in the November midterm election.

Moreover, if the inflation rate remains high next year, President Joe Biden could end up politically doomed as he gears up for the 2024 presidential race.

Indeed, Biden is old enough to remember that inflation that had reached a staggering 14.6 per cent was responsible for Democratic President Jimmy Carter's failure to get re-elected in 1980.

So now it seems that Biden is trying to place the blame for the soaring prices on a player that is not residing in Washington - Russian President Vladimir Putin. Call it the "Putin Inflation".

Following the report that showed consumer prices have spiked over 7.9 per cent over the last 12 months, Biden suggested that Putin's aggression in Ukraine was responsible for the rise in prices.

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"Today's inflation report is a reminder that Americans' budgets are being stretched by price increases and families are starting to feel the impacts of Putin's price hike,"Biden said in a statement, adding that a "large contributor to inflation this month was an increase in gas and energy prices as markets reacted to Putin's aggressive actions".

Unfortunately for Biden, this latest tactic is not going to work. Voters tend to blame a sitting American president for the country's economic problems, whether he or she was responsible for it or not.

Incorrect assumptions

The economic sanctions that the US and its allies have imposed on Russia, and in particular, the sweeping ban on Russian oil, may have put some upward pressure on inflation, especially when it comes to the rise in petrol prices.

But then, inflation has been rising for at least 6 months, well before Russia's invasion of Ukraine. And during most of that time, Biden administration officials blamed the price hikes on the pandemic and the ensuing supply chain issues, and insisted that the inflation was a "transitory" problem.

It is true that the huge increase in federal government spending in the form of trillions of US dollars to help American households and businesses in response to the pandemic by both Biden and his predecessor in office, Donald Trump, was responsible in part for the major rise in inflation.

But in this case, the blame needs to spread beyond the White House, since Democrats and Republicans in Congress signed on to these massive fiscal programmes.

If one is searching for the culprit in this story, the name that probably has to be attached to "inflation" is that of Federal Reserve Chairman Jerome Powell, like in the term "Powell Inflation".

Indeed, for more than a year, Powell and his colleagues in the Federal Open Market Committee (FOMC) have maintained that inflation will quickly subside and vanish.

During that time that coincided with the start of the post-pandemic economic recovery, Powell emerged as a so-called monetary "dove". He has pursued the same strategy he had embraced at the start of the pandemic - of pumping huge sums of money into the economy as part of an effort to prevent a financial and economic meltdown.

With the inflation rate remaining low during his first term in the Fed, Powell assumed, as rising unemployment emerged as a top threat after the deadly attack by the Covid-19 virus, that the central bank would be able to combat the prolonged unemployment through aggressive monetary policy while inflation continued to remain low.

Hence the decision made by the Fed in summer 2020 to continue maintaining rates near zero, while helping to lower long-term interest rates by buying US$120 billion in Treasuries and mortgage bonds each month until labour market conditions were consistent with maximum employment.

And, indeed, unemployment started to fall in the spring of 2021 to 4 per cent by January 2022, which seemed to fit with the Fed's strategy.

What Powell apparently did not expect was that inflation would start rising at the same time, driven by rising wages, growing demand for goods and shipping bottlenecks.

It was around that time that several economists, including Lawrence Summers, the Harvard professor and former top economic advisor for Democratic presidents, warned that the Biden administration's fiscal programmes were feeding inflation and advised the Fed to change direction and start raising interest rates as soon as possible before inflation would start getting out of control.

Powell did start taking the inflation threat more seriously by the end of 2021, when he presented a plan to reduce the Fed's monthly bond buying. But he refrained from taking bolder steps to combat inflation by raising interest rates or speeding the process of quantitative tightening.

Overly-optimistic assessments

The message coming from the Fed was that it expected inflation to fall eventually to 2 per cent, and that a gradual path of interest rate increases would be effective enough to deal with possible price increases propelled by rising economic growth and employment.

In retrospect, these assessments proved to be too optimistic, and critics argue now that Powell was too slow to admit his misreading of the inflationary threat. As a result, the steps that he would have to take now could lead to a recession, or worse, to stagflation, where the economy experiences a simultaneous increase in inflation and stagnation of economic output.

Last week, there were clear indications that Powell was finally beginning to control the worst inflation in 40 years, stating in a press conference that the US central bank needed to "restore price stability" after the FOMC decided as expected to raise the Fed funds rates by 25 basis points.

On Monday (Mar 21), Powell seemed to strike a tougher tone than he used in last week's press conference, suggesting during an address in Washington that the Fed was prepared to raise interest rates in half-percentage points and would continue to lift rates until it concludes that inflation is falling to its 2 per cent target.

The question is whether the Fed should have adopted a tighter monetary policy 3 months ago when it had wrongly forecasted an inflation rate of 2.6 per cent.

The Fed is now forecasting an inflation rate of 4.3 per cent and is hoping to achieve that through several interest rate hikes this year and in 2023.

While neither Putin nor Biden was responsible for the inflation, there is no doubt that the Russian leader's invasion of Ukraine would make the Fed's job more difficult, and that as far as the current White House occupant is concerned, what Powell does or does not do in the coming months would probably not improve his political fortunes by a lot.