In Jackson Hole, Powell faces soaring inflation and a major Fed test

Jackson Hole: Where Fed officials gather, and workers can’t afford to stay

Powell’s much-anticipated speech will also be crucial for his own credibility. In remarks for the conference last year, he doubled down on his belief that inflation would be temporary. The speech did not age well.

“The Fed feels like a passenger on the bus, along with Wall Street and investors and economists. The Fed doesn’t feel like the driver of the bus,” said Michael Strain, director of economic policy studies at the conservative American Enterprise Institute. “A way that you assert yourself as a driver of the bus is by stating clearly what you got wrong, explaining why you got it wrong, and communicating how you’re going to do things differently in the future.”

U.S. policymakers misjudged inflation threat until it was too late

To lower inflation from 40-year highs, the Fed must rely on one powerful tool: interest rates. Higher rates are designed to slow demand by making a host of loans, like for cars or mortgages, more expensive. The housing market, for example, is cooling, as a run-up in mortgage rates causes aspiring homeowners to bow out.

Inflation eased a bit in July, clocking in at 8.5 percent compared with the past year — down from the previous month’s high — as dropping gas prices helped lower overall costs. But Fed leaders say they need to see months of sustained improvement before knowing if rate hikes are working.

Compounding the challenge is that rate hikes operate with a lag, and the increases the bank makes now could slow down economic activity later this year or early next year. Already, the U.S. economy shrank in the first two quarters of 2022, raising fears of a recession and suggesting the economy is already slowing markedly, even while inflation remains high.

Inflation eased in July from a year ago, as energy prices fell

“July looked like there was some easing in those price pressures, but certainly not enough that you would say, ‘we’re in the right direction,’” Kansas City Fed President Esther George told Yahoo Finance on Thursday. “So I think we have more data to see. And I think we have more work to do, to begin to see that trend move down.”

Part of the problem is that interest rates are a blunt tactic, and they cannot address all the ways people feel inflation in their daily lives. Rate hikes can’t build new homes or keep gas prices low. And they can’t boost consumer sentiment, especially at a time when many families and business owners do not feel the economy is working for them, despite a strong job market and resilient consumer spending.

Politically, high inflation has weighed down President Biden’s approval ratings and complicated the Democratic Party’s legislative agenda. That’s not strictly a problem for the Fed, which is designed to be independent and whose officials serve terms that don’t directly line up with presidential administrations. But it does put the central bank’s work under closer scrutiny from politicians.

Earlier this month, the White House and congressional Democrats secured a major win with the passage of the Inflation Reduction Act, which focuses on the climate crisis, lowering health-care costs and raising taxes on large corporations. But Republicans continue to hammer Democrats for hefty stimulus packages earlier in the pandemic, and argue that any more federal spending or cancellation of student loan debt will overheat the economy further.

Fed hikes rates by three-quarters of a percentage point to fight inflation

For the Fed officials descending on Jackson Hole this week, the past few years have been dizzying. It remains exceedingly difficult for officials to get a clear read on the economy. And the cost of getting those assessments wrong has been high.

In last year’s Jackson Hole speech, Powell laid out the reasons he believed inflation would be a temporary feature of the economic recovery from the pandemic-induced recession. The Fed was getting closer to unwinding some of its emergency supports for the economy, but interest rate hikes were far from consideration. Powell also gave his speech virtually, since the summit was canceled during last summer’s delta variant surge of the coronavirus.

Twelve months later, and now back at Jackson Hole for the first time since the pandemic began, the Fed is in a race to rein in inflation that has risen higher and spread further throughout the economy. Supply chain snarls, high consumer demand and Russia’s invasion of Ukraine have kept prices high for gas, groceries, rent and everything in between. And suddenly, the central bank has been hiking rates at its most aggressive pace in decades.

The Fed has raised rates four times this year, most recently by three-quarters of a percentage point in July. The widespread expectation is that more increases will follow and the Fed will hike rates again at policy meetings in September, November and December. But it’s unclear whether central bankers will keep up with such sharp increases, or if they will decide to scale down the hikes to avoid slowing the economy too abruptly and causing a recession.

It would be unusual for Powell to use his speech to say exactly what the Fed plans to do next month. Still, the markets are closely monitoring for any signs of what’s to come. Stocks could rumble on Friday if Powell is more forceful, or more relaxed, than expected.

“He has wanted to tell a somewhat hopeful story: ‘this is something we can accomplish,’” said Tim Duy, a Fed expert at the University of Oregon and chief economist at SGH Macro Advisors. “‘We know that inflation is hurting all of you, and we want to rectify that situation, but we don’t want to do it in such a way that creates more pain.’”