Powell’s Playbook

Federal Reserve chair Jay Powell borrowed the game plan of one of his predecessors to fight inflation but he slid into third base instead of hitting a home run.

Powell’s strategy to combat rising prices is like the one fielded by the late Paul Volcker. The former chairman of the Federal Reserve, Volcker, sharply boosted the cost of borrowing money in the 1980s to slow the economy and cut the rate of inflation, which had climbed above eleven percent. He succeeded and became a hero in the financial markets, even though his playbook triggered painful and unpopular back-to back-recessions.

Now more than thirty years later, the Federal Reserve led by Powell has adopted Volcker’s playbook. He’s jacked up interest rates eleven times since March 2022, including the one expected to be announced on Wednesday as the central bank struggles to restrain an inflation rate that had reached nine percent. 

photo courtesy Getty Image

So far, though, Powell’s game plan has only cut inflation to about three percent, and more increases are coming as the central bank slowly moves to reach its’ target of two percent inflation. As a former economics reporter for the Chicago Tribune, I continue to follow the Federal Reserve’s challenge closely, and I fully expected that the central bank’s progress would be slower. My reasoning: The economic playing field has changed a lot since Volcker’s tenure. America just doesn’t make as much stuff as the nation’s workers used to, complicating Powell’s challenge as he tries to round the bases and declare victory.

When Volcker sat at the chairman’s desk at the Federal Reserve’s white marble headquarters building on Constitution Avenue in Washington, goods producers, or the companies that borrow lots of money to make everything from cars and washing machines to valves and electric lights, employed about thirty percent of the nation’s workforce. When interest rates are low, goods producers typically borrow buckets of money to fund their operations, build new factories, hire more employees and raise wages, all of which can lead to inflation and makes the companies more vulnerable to interest rate policies. When interest rates rise, they cut back, particularly when rates soar to more than twenty percent as they did under Volcker. In fact, goods producers accounted for ninety percent of the job losses in 1982 thanks to high rates and recessions Volcker threw their way. 

Powell plays in a new ballgame, one that is in many respects more tricky. The latest figures from the Bureau of Labor Statistics say the goods producers now account for only about fourteen percent of the workforce. In other words, the interest rate increases don’t have the wallop they used to for goods producers, because we don’t have as many employers in the goods producing industries. Indeed, much of the job growth in America since the 1980s came in the services industries, jobs like lawyers and consultants or waitresses and Walmart greeters. The companies that employ them are less sensitive to interest rate increases and cuts because they typically don’t borrow so much money to fund their operations or take on large projects when money is cheap. Changes in Federal Reserve policy tend to have a slower and less pronounced impact than with goods producers. In fact, the service industry companies, which also are characterized by many workers who earn less, are the ones still having a hard time finding workers, propping up the employment numbers that worry inflation fighters at the Federal Reserve.

If Powell wanted to avoid a recession, he had to make policy changes that raised interest rates more incrementally and gradually. In my baseball metaphor, he has to hit double and singles — not home runs — to win the game. 

That’s what he is expected to do after the central bank’s meeting scheduled to end July 26th when he will no doubt announce the eleventh incremental interest rate increase. Powell and his team are watching the employment and consumer confidence numbers hoping to see the economy grow, only at a slower rate.

There’s evidence that his game plan is paying off. The economy is still growing at a healthy clip, but there are signs that things are starting to slow down. The Consumer Price Index for June, released this Wednesday, showed the inflation eased to three percent in June, the slowest pace in more than two years. The numbers suggest that economy is working off some of the supply chain issues triggered by the pandemic. But the slower progress should be expected since restraining price increases in the service industries usually adjust more slowly to Federal Reserve policy moves. 

Of course Wall Street is like the fans in the grandstands who cheer, boo, and second guess the manager on how he’s handling the line up and the players. Don’t get too worried about the speculation and commentary by traders, investors and pundits, though. I’m going to sit back and continue to watch the game. Powell’s goal is a so-called “soft landing” for the economy. That occurs when the Federal Reserve walks its targeted inflation rate back down to two percent without causing a recession.

I think we are in the seventh inning and it’s time for the stretch. We’ve seen Powell manage to cut the rate of inflation by two thirds since last March without a recession. That’s pretty remarkable. Maybe sticking to third base is not such a bad thing. 

—James O’Shea

James O’Shea is a longtime Chicago author and journalist who now lives in North Carolina. He is the author of several books and is the former editor of the Los Angeles Times and managing editor of the Chicago Tribune. Follow Jim’s Five W’s Substack here.