By Ann Saphir
(Reuters] – The U.S. central banking officials will hold their annual meeting on Tuesday. Already, they are in agreement about raising interest rates quickly, most likely in March, in order to slow down the economy.
The White House is not likely to tell them anything.
It marks a dramatic reversal in the Federal Reserve’s direction and Jerome Powell as its chair. Trump was critical of Powell’s 4 interest rate rises in 2018, which he had only just done to make the Fed more efficient and felt it undermined his efforts to promote economic growth. Trump used public pressure campaigns to prevent them.
Instead, President Joe Biden has supported what the Fed indicated will be three or more interest rate increases this year. He also suggested a rapid shrinking its almost $9 trillion balance to increase borrowing costs. Biden last week called Powell’s policy retooling “appropriate”, and stressed that it was the Fed’s decision.
What is the point of this difference? It doesn’t matter if there are two presidential styles. The main thing is inflation.
Trump’s first four year term saw consumer prices rise at a rate of 2% per annum and not faster than 3%. Biden was the first to see them rise 7%, and this is because demand for every product from cars to hamburgers was far greater than the economy’s ability.
Sarah Binder from George Washington University, who wrote a book in 2017 on Fed governance, said that Biden “understands that Fed performance will affect the economy’s course and help shape his electoral fortunes”
As businesses seek to attract workers following pandemics or other dislocations, higher prices are affecting paychecks.
They are also tanking Biden’s approval ratings https://www.reuters.com/world/us/biden-approval-rating-drops-43-lowest-his-presidency-2022-01-20 and have generated comparisons to the 1970s, when President Gerald Ford tried to force businesses into holding the line on prices and his successor Jimmy Carter appointed an inflation hawk – Paul Volcker – to finally end the upward spiral.
Biden actually bets on the Fed’s move to tighter policy and is not fighting them.
If all goes well, Fed will raise rates to slow down demand from the current low levels. This will make it more costly for businesses and consumers to borrow money.
Powell says the economy is strong enough https://www.reuters.com/article/usa-fed-powell-idCNL1N2TR1FJ to handle it and in fact will not be able to grow at its full potential if inflation stays high for too long and gets entrenched in business and household psychology.
He hopes that help will be provided in the areas where he is unable to control, like supply chains and pandemics. Untangled supply chains will allow businesses to get the necessary parts and materials much more easily. That reduces upward pressure. The pandemic could ease, and more people who had to stay out of work because they were worried about their health or have children may find employment again, which will decrease upward wage pressure.
Biden backing Powell could also be dangerous because he is supporting a toxic combination – a Fed tightening its policy at the same time as declining government aid to support demand last year, and supply chains that are still tangled. The uncertainty could be exacerbated by tensions at the Russian-Ukraine border.
This could lead to a Fed policy that is more restrictive than the economy can handle.
FED CREDIBILITY ON-LINE
Biden is betting on Powell’s success by renominating Powell for a second term that will begin next month. Powell hopes to raise rates quickly enough to keep inflation in check, but not too fast so as economic growth slows down.
“If there’s no ‘soft landing,’ a recession would put Biden in even greater electoral danger,” Binder said.
Biden and Treasury Secretary Janet Yellen have been trying to revive his stalled spending plans, which aimed to lower the cost of childcare as well as allowing more parents to return to the workforce. They are also hoping to correct the failed supply chains which have pushed up prices.
It is unclear if their efforts will succeed and if slow rate increases that the Fed has signaled so far will suffice to reduce inflation.
Goldman Sachs’ (NYSE:) economists stated earlier in the month that if the Fed wants to play a greater role in bringing down inflation – rather than waiting for the effects from pandemic demand imbalances and fiscal stimulation to fade – it must do enough to tighten material financial conditions.”
This could, according to them, lead to at least four rate increases this year.
Two months of additional inflation data will be available before the Fed meets in March. This should show whether or not it is cooling off as predicted by policymakers last year, but it has been wrongly projected to do so repeatedly.
The Fed might need to increase rates if inflation keeps rising, and may also need to make them sooner, said Tim Duy of SGH Macro Advisors.
Duy stated that this is especially true given the rising political cost of inflation. He also noted that there are political risks not only to the Biden administration but also to the Powell Fed.
Duy said that to maintain its credibility on Capitol Hill and with the public, it must meet its mandate of maintaining 2% inflation per annum.