Jerome Powell, chairman of the U.S. Federal Reserve, is reflected in a table while signing an appointment affidavit after taking the oath of office as chairman of the Board of Governors of the Federal Reserve in Washington, D.C., U.S. (Photographer: Andrew Harrer/Bloomberg)  

Powell’s Message Wasn’t Necessarily About Rates

(Bloomberg Opinion) -- Seconds after Federal Reserve Chairman Jerome Powell’s speech was released on Wednesday, the market surged, apparently pleased by his comment that interest rates are “just below” the Fed’s estimates of the neutral rate. This is an overreaction: Powell’s language is not especially new, echoing the message he delivered in last September’s press conference.

The more significant message from today’s speech concerns Fed policy more generally. Powell is undoubtedly mindful of Milton Friedman’s warning that an excessive focus on the short term can make the Fed like “a fool in the shower,” constantly oscillating between hot and cold. So he put renewed emphasis on the long-term effects of Fed policy — especially on how long it takes for it to affect the economy. On this he is surely right — and it argues for a pause in interest-rate increases sooner rather than later.

This slow-acting nature of Fed policy means three things. First, the impact of this year’s tightening has not yet been fully felt. Any weaknesses evident now are going to be compounded by the slowdown caused by the rate increases that have already taken place. Second, even if the Fed halts its rate increases next year, its overall policy — mainly, winding down its balance sheet — will tend to have a slowing effect on the economy. Third, once a downturn starts, it is hard to stop. Any effort to mitigate a downturn has to begin prior to the downturn.

Given these factors, the risks of continued rate increases are building. Meanwhile, growth in Europe and China is slowing. The housing market is weakening. Stock prices have sharply declined and the yield curve has continued to flatten. If the Fed waits any longer, it will be too late.

By comparison, If the Fed pauses its rate increases, it is very unlikely that inflation will spike higher than the Fed’s target. Inflation pressure is falling, and declines in housing and stock prices will contribute to that by weakening consumer spending.

I don’t think that Powell was attempting to telegraph anything to the markets with today’s speech. I do believe, however, that a change in policy is called for.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Karl W. Smith is a senior fellow at the Niskanen Center and founder of the blog Modeled Behavior.

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