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Jerome Powell’s Brewing Dilemma
It’s been a rather challenging year for Jerome Powell, the chairman of the Federal Reserve. Sadly, the latter half appears even more daunting.
The Dual Threat
The conundrum before Powell is quite unique. President Trump’s tariffs threaten to drive up consumer prices. Meanwhile, the labour market shows signs of wavering. Indeed, job openings are on the decline, with small businesses reporting sluggish sales and diminished hiring intentions.
According to Neil Dutta from Renaissance Macro Research, there’s a discernible correlation between weak small business sales and the unemployment rate. This paints a rather troubling picture for the future.
Inflation vs. Employment
The Federal Reserve has two central mandates: controlling inflation and bolstering the labour market. This balancing act becomes complex when the two appear contradictory. When inflation accelerates, they raise rates to cool things down. Conversely, if the labour market falters, they cut rates to spur growth.
Recently, the fed funds rate hovered above 4%—a measure against rising prices. The anticipated recession hadn’t materialised; the Federal Reserve had begun cautiously lowering rates to ensure a ‘soft landing’.
The Tariff Tangle
Then, along came Trump’s tariffs. Now, the Federal Reserve faces a problem somewhat akin to the Smoot-Hawley Act of the 1930s, though we’re not emerging from a Great Depression, and inflationary pressures linger.
Tariffs: A Delicate Balance
So far, these import taxes haven’t trickled down to consumer prices. Companies have been stockpiling inventory since late 2024. However, once their reserves deplete, higher prices might cascade down to consumers. As Gagnon of the Peterson Institute suggests, firms are bound to push these costs forward once margins get squeezed.
The Inflationary Spiral
Gagnon warns that expectations of inflation can lead to actual inflation. It’s a self-fulfilling prophecy. If businesses expect others to raise prices, they’ll swiftly follow suit, and workers will demand higher wages. The key is evading this spiralling situation.
The Road to Financial Stability
Yet, raising rates to keep inflation in check carries its own set of perils. There’s a risk of financial panic—the dread of soaring bond rates looms large. Hetzel reminds us, “The Fed’s in a box.”
Both Hetzel and Gagnon liken tariff-induced inflation to an oil shock. Prices may spike temporarily and then plateau. However, if the Federal Reserve mismanages, it could lead to chaos.
The Memory of Recent Inflation
Moreover, we are still recovering from recent inflation surges. Consumers might be quick to react, fearing another episode lasting several years. The spectre of past inflation looms over leaders, reminding them of their earlier claims that it was “transitory.”
Indeed, Powell’s path is fraught with challenges. Maintaining an equilibrium between inflation and employment amidst tariff pressures demands precision and a steady hand. Only time will tell how successfully he manages this delicate dance.
