BREAKINGVIEWS-Powell’s task: reshaping weapons for the last war

By Gabriel Rubin

WASHINGTON, May 28 (Reuters Breakingviews) - Federal Reserve Chair Jerome Powell wants the central bank's tools to reflect its current wars, not its past ones. After years of seeking escape from miserly growth, the central bank’s sluggish response to post-pandemic inflation came late and rushed. Now, the public opinion that it sought so hard to manage risks slipping from its grasp, with Americans expecting price rises to top 7% next year. An impending review of Fed operations gives Powell a chance to formally tilt its attention back toward inflation-suppression, even at the expense of the other side of its dual mandate: maintaining full employment. Despite political pressure otherwise, only the threat of punishing rates can wrest control of the narrative back.

Powell is squeezed between President Donald Trump, who is pounding the table for lower rates while enacting cost-hiking trade levies, and legislators shaping a budget-busting tax-cut bill. Under these conditions, consumer inflation expectations -- as reflected in a recent University of Michigan survey -- make sense, even as they gyrate with Trump's contradictory proclamations.

This is a very different challenge from the one the Fed spent the 2010s trying to fight. The central bank reviews its policy framework every several years. Its last rethink, in 2020, sought to tolerate a modest uptick in the rate of price rises without quashing growth. The answer was “average inflation targeting,” under which the Fed would seek to stay within its 2% inflation goal over a period of time, rather than overreacting to any brief overshoot. This was the culmination of years of reforms dedicated to better communicating the bank’s stern intent to support its other statutory mission -- full employment -- despite having no room to cut rates. It was obsolete almost as soon as it was written.

The 2020 framework was “too focused on the experience following the financial crisis,” William English of Yale University and Brian Slack of Balyasny Asset Management concluded last year. Tilting the scales back likely means ditching the idea of averaging, which hasn't worked in an era where the upside risks outweigh downside ones. Ben Bernanke, the Fed’s crisis-era chair, suggests that staff generate quarterly economic reports and forecasts. The idea is to better indicate why the bank is doing what it’s doing, avoiding distractions like comments from a single dovish board member.

A swing towards vigilantly crushing inflation could of course overstep, resulting in unnecessarily high rates that slow economic growth and raise unemployment. The need, though, is acute. The average weighted U.S. tariff rate is now 17.8%, according to the Yale Budget Lab, the highest since 1934. The possibly $4 trillion of debt over a decade resulting from planned tax cuts could crowd out private investment and raise financing costs. These are incredibly strong signals to the public. The Fed’s mission is to shout even louder.

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CONTEXT NEWS

U.S. Federal Reserve Chair Jerome Powell said on May 15 that the central bank’s regular five-year review of its monetary policy framework would result in adjustments, adding that “the economic environment has changed significantly since 2020.”

The 2020 review resulted in the introduction of a practice known as average inflation targeting, under which the Fed will allow price rises to run above 2% after a period of particularly low inflation in order to average out to the central bank’s target.

Year-ahead consumer inflation expectations have surged, hitting 7.3% in the University of Michigan’s survey conducted between April 22 and May 13.