If you’re an economist dithering about inflation, you’re allowed to make mistakes. However, if you’re the head of the world’s most powerful central bank, you need to be a lot more careful. Any mistakes you make are fraught with consequences.
When Federal Reserve Chairman Jerome Powell blithely asserted about a year ago that inflation would be transitory, he made what economist Mohamed El-Erian later called a historic mistake. El-Erian might have been wrong, but he had a lot of company in his assessment—not least, Harvard economist and former Treasury Secretary Larry Summers, who inveighed for months about the burgeoning risk of inflation.
Powell has long since had to admit inflation is not transitory, and earlier this month he even acknowledged the Fed should have moved sooner, although he added that this realization only comes from hindsight. Not really... others were sounding the alarm at the time.
And it looks like the Fed chairman is about to make another mistake.
Powell has already committed to raising interest rates no more than a quarter-point at this week’s meeting of the Federal Open Market Committee. And he made the pledge even before the consumer price index for February registered a year-on-year increase of 7.9%.
Powell put himself on the record for limiting the increase, even though other FOMC members were openly speculating about a half-point hike.
Part of the problem is that Powell, a lawyer who made a fortune in private equity, has to rely on staff economists and their models for his judgments about the economy. And these economists are anything but neutral scientists analyzing information.
Politicized Advisors, Enduring Inflation?
While it was puzzling that Powell so stubbornly maintained inflation was a temporary phenomenon resulting from supply chain disruptions, an op-ed in the Wall Street Journal last week offered a clue about why he stuck to this forecast.
Emre Kuvvet, an associate professor of finance at the Nova Southeastern University in Florida, painstakingly combed through voter-registration databases to tabulate the politics of the Fed’s more than 780 economists. He found a massive preponderance of left-leaning affiliations. The overall ratio of Democrats to Republicans among the Fed's system economists was 10.4 to 1.
It was even more dramatic in the Washington-based board of governors, where the ratio of Democrats to Republicans was 48.5 to 1. These are the staff economists who feed the policymakers the data they use to make monetary policy decisions, and Kuvvet’s analysis provides evidence of bias in their backgrounds.
This scholar’s point is that the Fed is already deeply politicized, beyond whatever affiliation the governors themselves demonstrate. In the past, the White House made a point of balancing Democratic and Republican nominations to the board, but all three of President Joe Biden’s new appointments to the board are Democrats, and his choices for two Vice-Chairman positions share his party affiliation.
In the meantime, British economist Charles Goodhart, a former member of the Bank of England’s Monetary Policy Committee (the UK equivalent of the FOMC), says that inflation is here to stay because of major demographic shifts that dictate labor shortages—and wage pressure—for the foreseeable future.
His 2020 book, "The Great Demographic Reversal," co-written with Manoj Pradhan, says the addition of hundreds of millions of cheap workers in China and Eastern Europe to a global economy kept prices low in the past decade. Those days are gone, and labor shortages will push up wages and prices. His views are now gaining a lot of attention, although critics say he puts too much weight on demographics.
Even Janet Yellen, the former Fed chair who has been a loyal Treasury secretary, said last week that inflation will remain uncomfortably high for another year, even as the White House was describing it as temporary and not long lasting.
The European Central Bank, meanwhile, said the war in Ukraine would increase inflation and dampen growth in Europe over the next two to three years.
In response, the ECB said after its policy meeting last week it will scale back its bond purchases, reducing net purchases to €40 billion ($43.6bn) in April, €30bn ($32.7bn) in May, and €20bn ($21.8bn) in June. Previously, it planned to reduce purchases to €20bn only by October. The central bank may cease new purchases already in the third quarter.
However, the ECB no longer guarantees it will raise interest rates soon after it stops bond purchases. Rather, it will determine interest rate policy according to incoming data on inflation and growth.