If Jerome Powell thought up until now that he had a difficult task ahead of him, he now knows at the latest that it is an almost impossible one: of all times, in a time of chaos, war and uncertainty, the head of the US Federal Reserve (Fed) with a series of precise yet bold, rapid and yet cautious key interest rate increases, ensure that the record inflation rate in his country finally falls – and all this without sending the economy into recession at the same time. Central bankers around the world have failed with simpler problems.
As of Wednesday night, Powell and his comrades now have the start button on theirs Mission Impossible depressed and the most important guiding principle raised by a quarter of a percentage point to between 0.25 and 0.5 percent. The decision initially has more symbolic character than real economic effects, but its importance should not be overestimated: the most powerful central bank in the world is making it clear that it no longer wants to tolerate a further increase in the wave of inflation and wants to prevent a price tsunami that would sweep everyone away . The era of zero interest rates is over.
Finally, one has to say, because the decision comes late, maybe too late. For months, the Fed had retreated to the argument that the price increases were only the result of corona-related delivery problems that would eventually resolve themselves and that monetary policy could not solve anyway. After all, a central bank can neither produce oil itself nor unload container ships or build computer chips.
That was all right – and yet wrong: namely, inflation does not only occur when demand in a market is greater than supply. It arises primarily from the fact that citizens, managers and exchange traders believethat prices will continue to rise – and adjust their behavior accordingly. The Fed could have countered this danger, known as “unanchoring of inflation expectations” in central banker jargon, much earlier by giving a stop signal verbally and finally by raising the key interest rate. Instead, she has tried to lull herself and the world with soothing formulas.
The question now is how to proceed. Before Vladimir Putin’s attack on Ukraine, most experts had assumed that the first interest rate hike that has now taken place this year and next will be followed by six or seven further steps, maybe even more. Even this strategy should have been constantly checked, after all it is completely uncertain what atrocities the corona virus still has in store for mankind and its economies.
The struggle for Ukraine, which is taking the lives of so many thousands of meaningless innocents, complicates matters for the Fed even more: nobody but the warlord in the Kremlin knows how long this ill-fated campaign will continue, what human and economic devastation it will bring still wreaks havoc and to what extent it will further fuel inflation. For the Fed leadership, which is in a hurry to embark on a significantly more aggressive rate hike course, this means that strategic medium-term planning is hardly possible. In fact, she will have to completely redefine her path every six weeks with each new session.
A very hard step on the brake is not necessary
The good thing is: Powell can do that. He is not a dogmatist, but a pragmatist, he corrects misjudgments and resists political pressure, all of which he proved both during the corona pandemic and during the unspeakable attacks on him by former President Donald Trump. And another good thing is that, unlike in previous cycles, interest rates are not rising from an average value, but from zero. This means that even after five or six increases of a quarter percentage point each, the rates would still be very low in a long-term comparison and far from a level at which economic development would be stalled.
At the same time, a very hard step on the brakes is not even necessary, because a not inconsiderable part of the price pressure is actually based on problems that should disappear again over time. On the other hand, other potential drivers of inflation, such as the increasing shortage of skilled workers in many industrialized countries, will remain, which makes it all the more urgent to normalize the unnaturally low interest rate level, especially in the USA and Europe.
Either way, anyone looking at things from Germany can only wish the Fed’s executives the best of luck. Because whether the Federal Republic is facing prosperous or rather painful economic times depends, among many other things, on whether Powell and his comrades-in-arms succeed in their extremely delicate mission.