July 1, 2022 – September 30, 2022
Gas prices peaked in June, 2022 and then started to slide in July. The stock market took this as a sign that inflation was easing. Stock market traders assumed the Fed would ease interest rates, and so they started buying stocks again. The stock market posted gains by the end of July.
But stock trader’s inflation assumptions proved both hasty and inaccurate. When the Bureau of Economic Analysis (BEA) put out its report on July, Personal Consumption Expenditures remained a stubborn 4.6% over where prices were one year before. This measure excludes more volatile food and energy prices, which were up an eye-popping 11.9% and 34%, respectively.
On August 26th, Jerome Powell spoke at the Central Bank’s annual symposium in Jackson Hole, Wyoming. He stated in unwavering terms that the Fed would continue to raise interest rates as long as necessary to curb inflation. Interest rate increases were the sharpest tool in the Fed’s kit to cut inflation down to size, and Powell made it clear he was willing to use that tool until the job was done and done properly.
Interest rates determine how expensive it is to borrow money. When interest rates are low, borrowing is relatively easy. Companies can expand with borrowed money instead of raising capital or plowing profits back into the business. When interest rates increase, it becomes harder for both individuals and companies to borrow money or pay on credit, so fewer goods are sold. When fewer goods are sold, fewer people are needed to make the goods, and people get laid off. At least that is what happened in the 1970s.
It was the ticking up of unemployment numbers in the 1970s that caused the Fed to reverse itself on raising interest rates. Back then, the U.S. economy centered around manufacturing. An unemployment rate of 6% was considered full employment at that time. Today’s unemployment rate is 3.5% and yet employers are howling for more workers. In other words, interest rate increases may cool demand and borrowing, but it may not necessarily lead to widespread unemployment.
Under the Administrations of Richard Nixon, Gerald Ford, and Jimmy Carter we had hyper-inflation. Nixon attempted wage and price controls that did not work. Ford championed a campaign to Whip Inflation Now (acronym WIN), but it was largely confined to red and white lapel buttons. It was not until Jimmy Carter nominated his second Fed Chairman, Paul Volker, in 1979 that inflation was controlled by the steady pressure of interest rate increases. (The Reagan Administration retained Volker in 1981.) The rate of inflation peaked at 14.8% in 1980, then eventually slipped below 3% by 1983 thanks to a Fed Fund rate (the cost to borrow money) that rose from 11.8% when Volker accepted the Chairmanship to 21% in June of 1981. As a basis of comparison, the current Fed Fund rate is 3.25%.
Many believed that if Volker’s predecessors, G. William Miller and Arthur F. Burns, had simply raised interest rates as inflation started to tick up, they could have nipped it in the bud. Instead, they lost their nerve as unemployment increased correspondingly.
Powell wanted everyone listening to know that he was not going to back down. He learned the lessons history taught us, and he had absolutely no intention of making the same mistake. Characteristically, stock market traders reacted with all the grace of a newly grounded teenager. Markets dived.
Powell was not just speaking to Wall Street, but to all of corporate America. The Pandemic did cause supply chain issues, which lead to scarcities of certain critical goods like computer chips that held up manufacturing. But there were also price increases that were simply opportunistic; for example, rent increases that did not correspond to any discernable improvements to the property or a greater demand for housing.
A recession is measured by “two consecutive quarters of negative growth.” Negative growth is one of those economic oxymorons that obfuscate rather than illuminate. Why we don’t simply use the work “contraction,” I do not know. Basically, a recession means that the value of the economic output of a country became smaller. That doesn’t necessarily mean a recession is a bad thing. If you had a swollen limb that with repeated treatments returned to its normal size, you would likely think that was a good thing. Jerome Powell would likely agree with you. We just need to be patient while Chairman Powell treats this inflammation.