Powell Laughs Off Stagflation

Damir Tokic |

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Fed Chairman Powell signaled a hawkish turn at the Wilson Center's Washington Forum on April 16. Among other things, Powell said: “Right now, given the strength of the labor market and progress on inflation so far, it's appropriate to allow restrictive policy further time to work and let the data and the evolving outlook guide us.” The implication of this statement was that the Fed was possibly abandoning an easing bias and returning to a "higher-for-longer" policy stance. Thus, many analysts expected that the Fed would officially confirm a hawkish turn at the May FOMC meeting. Instead, the Fed added this sentence: “In recent months, there has been a lack of further progress toward the Committee's 2 percent inflation objective.” This new sentence confirms that the Fed still has an easing bias, and still views the recent spike in inflation as a temporary bump. Powell flatly rejected the possibility of another interest rate hike and suggested an asymmetric policy response to inflation and growth. Specifically, Powell suggested that the Fed would cut immediately in case of unexpected weakening in the labor market, but not necessarily hike in case of hotter inflation. Powell has flip-flopped many times. Two weeks before the Fed's December 2023 meeting, Powell stated: "It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease." And then at the December 2023 meeting, the Fed made a major dovish turn, canceling the last interest rate hike, and signaling three interest rate cuts in 2024. The result of the December 2023 premature dovish turn is the current situation of accelerating inflation – due to loosening of the financial conditions. Recent economic data suggests the US economy could be slipping into stagflation. Specifically, the Advance Q1 2024 GDP showed a below expectations 1.6% growth, and above expectations 3.7% inflation. ISM manufacturing for April showed that growth is contracting, but the prices paid are soaring. At his FOMC post meeting conference, Powell actually laughed at the idea of stagflation: “I was around for stagflation, and it was 10% unemployment, it was high-single-digit inflation. And very slow growth. Right now, we have 3% growth which is pretty solid growth, I would say, by any measure. And we have inflation running under 3% … I don’t see the ‘stag’ or the ‘flation,’ actually.” Powell was referring to the stagflationary environment of the 1970s and early 1980s, contrasted with today's environment. Clearly, the economic data today does not resemble the data at the peak of stagflation in 1974 and 1980. But there were three inflationary spikes during the 1970s and 1980s, with disinflationary periods in between. How can Powell be sure that we are currently not in-between two inflationary spikes? Given the Fed's dovishness, it is actually likely that we could be facing a second wave of inflation.