The Financial Gauges Are Going Nuts. Jerome Powell Is Taking a Longer View.

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The economy is changing so quickly that understanding it is no easy task. In a matter of months, the United States has gone from unemployment and low prices to widespread labor shortages and uncomfortably high inflation.

In this extremely unusual recovery, the signals used by economic policymakers to make their decisions are jumbled. For example, what about the combination of strong employment and wage growth coupled with millions of working-age people who appear to have no interest in returning to work?

It’s easy to imagine Federal Reserve chairman Jerome Powell as a pilot in uncharted territory with broken gauges. He does what one would want a pilot to do under these circumstances: look to the horizon.

A recurring topic on Wednesday when he spoke to the media after a Fed policy session was his focus on the things that haven’t changed about the economy, the lessons of the 2010s expansion. He defies the urge to conclude that the pandemic has fundamentally changed key dynamics.

These are the lessons for Mr. Powell: American workers are capable of great things. The labor market can run hot longer than many economists once thought, with far more positive results. There are many strong structural forces that will keep inflation in check. For these reasons, the Fed should be cautious about hike rates rather than risking stalling a full economic recovery too soon.

He is deeply optimistic about the years to come. He sees the labor shortage in 2021 not as evidence of permanent scars in the potential of American workers, but as a reflection of the difficulty of reopening large industries and redistributing workers after a pandemic.

“You look at the current timeframe and look a year and two ahead – we’re going to have a very, very strong labor market,” said Powell, describing an environment of low unemployment, high employment rates and “rising wages for people across the spectrum.” . “

And he rejected the possibility that both wages and prices would turn into an ongoing 1970s-style spiral.

“Is there a risk that inflation will be higher than we think? Yes, ”said Mr. Powell. “We are not certain of the timing or extent of this reopening impact.”

But he added, “We think it is unlikely that they would materially affect the underlying inflationary momentum that the economy has had for a quarter of a century. The underlying forces that created this dynamic are intact. ”These include globalization and an aging world population.

If you screw up your eyes you can even see the lessons of three great missteps applied to Mr. Powell’s career as a central banker.

In 2013, as Fed governor, he helped get Chairman Ben Bernanke to “slow” the rate of bond purchases under the Fed’s quantitative easing program, unleashing global financial turmoil and prompting the central bank to change course. (As a sign of how deep the scars from that experience are, Mr Powell said cautiously on Wednesday that at that meeting they were merely talking about reducing their current QE purchases, which was itself a subtle departure from his previous guidance that it wasn’t time to talk about tapering.)

In 2015, Mr. Powell endorsed a decision to raise interest rates to prevent inflation from rising. It also created global economic problems – and an under-the-radar economic slowdown in the United States – although the American labor market still had much room for improvement in hindsight.

And in 2018, under his leadership, the Fed raised rates four times, despite no inflationary pressures. The latter in particular turned out to be a mistake within a few days, and Mr. Powell soon turned back.

At each of those points in time, the people who argued that the American labor market is already or near its potential – a fundamentally pessimistic view of the number of people who could be brought to work with the right mix of compensation and employment opportunities – looked with it wrong in hindsight. So did the people who routinely predicted an outbreak of problematic inflation was imminent.

The risk with this approach is that Mr. Powell is actually fighting the final battle – applying the lessons of these episodes to a different economic environment.

After all, there are some differences between then and now. Most importantly, fiscal policy has now acted on a much larger scale, and the trillions of dollars flowing through the economy certainly create different types of inflation risk. All other things being equal, looser fiscal policy – larger persistent deficits – means that tighter monetary policy is required to contain inflation.

In addition, there are – early but striking – some signs of a more sustained change in the power dynamic between capital and labor. Workers seem to have the upper hand over employers in a way they haven’t in a generation.

This could turn out to be a temporary consequence of the post-pandemic moment and is mostly positive (Mr Powell expressly describes higher wages and more expansive job opportunities as good). But if we go back to a 1960s-style dynamic where workers are demanding wages higher than justifiable increases in productivity, and employers are happy to give them to them and raise their prices, it means Mr Powell’s Fed turned on is tracking to get behind the inflation curve.

Ultimately, the question of whether the Fed is on a smart course will depend on whether the pandemic has fundamentally changed things or just created a miserable year for the economy after which things will normalize again.

One trait Mr. Powell has shown, including in the 2013, 2015, and 2018 episodes, is a willingness to turn if his judgment is found to be wrong. The best hope for the 2020s economy is that its pilot’s gaze is right on the horizon. Second best is that it adapts quickly if it turns out to be wrong.