The raising of interest rates has come late — perhaps too late. But the world can hardly do anything else but hope that Fed Chair Jerome Powell is successful in the fight against inflation.
If Jerome Powell once thought he had a difficult task in front of him, he now knows that it is a nearly impossible one: precisely, during a time of chaos and uncertainty, the chair of the U.S. Federal Reserve, also known as the Fed, is supposed to use a series of interest rate increases that are precise, yet determined, and swift, yet cautious, to finally bring down the record inflation rates in his country and to accomplish all that without sending the economy into a recession. Government bankers across the world have failed in the face of much easier challenges.
On Wednesday evening, Powell and his colleagues pressed the start button for this “mission impossible” and raised its most fundamental rates for the first time since 2018. For now, the decision has more of a symbolic character than any true economic impact, but its importance cannot be overstated. The most powerful central bank in the world is thus making clear that it will not tolerate any further intensification of inflation and that it wants to prevent a price tsunami that drags everything along with it. The era of zero interest rates is over.
Finally, it must be said, because this change of course is coming late — perhaps too late. For months, the Fed had held back with the argument that the rise in prices was just a consequence of supply-chain problems caused by the coronavirus pandemic and could not be solved through financial policy. After all, a federal reserve cannot itself boost oil production, unload ships or build computer chips.
That was all true but also wrong, namely because inflation does not only occur when market demand exceeds supply. It also occurs when citizens, managers and stockbrokers believe that prices will continue to go up, and they change their behavior accordingly. The Fed could very well have confronted this danger earlier by drawing a verbal red line and increasing interest rates at the beginning of the year.
Just Weeks Ago, the Fed Itself Could Not Have Imagined Taking Such an Aggressive Approach
Vladimir Putin’s attack on Ukraine is now making the situation even more complicated because the full extent of the war’s economic consequences is not yet apparent. For the Fed, which is now hurrying to institute a program of interest rate increases with an aggressiveness that even it probably didn’t expect, it means that strategic planning is hardly possible in the intermediate term. Instead, it will have to redirect its path week by week, month by month.
The good thing is that Powell can do it. He is not a dogmatist and is not afraid to correct mistakes. And another good thing is that interest rates are increasing not from an intermediate value, as in previous cycles, but from zero. That means that even after six or seven increases, rates will still be very low from a multi-year perspective. At the same time, it is not even necessary to step on the brakes too hard because this inflation is due in part to problems that should disappear on their own with time.
In any case, watching from Germany, we can only wish the Fed leadership good luck. Because whether the Federal Republic is entering a prosperous or a rather painful economic era depends, upon many other things, in great part on whether Powell and his colleagues succeed in their very perilous mission.