Insights from Fed Chairman Powell’s speech in Jackson Hole

WASHINGTON (AP) — Federal Reserve Chairman Jerome Powell virtually declared a victory in the fight against inflation and announced that interest rate cuts are imminent in a highly anticipated speech Friday in Jackson Hole, Wyoming.

Under Powell, the Fed raised its benchmark interest rate to its highest level in 23 years in an effort to curb inflation, which two years ago was at its highest in more than four decades. Inflation has been falling steadily, and investors now expect the Fed to begin cutting rates at its next meeting in September – an expectation Powell essentially confirmed on Friday.

Powell declares victory over inflation

“My confidence has grown that inflation is on a sustainable path back to 2%,” Powell said in his keynote speech at the Fed's annual economic conference in Jackson Hole.

He noted that inflation, according to the Fed's preferred measure, has fallen from a peak of 7.1% two years ago to 2.5% recently. As measured by the more popular consumer price index, inflation has fallen from a peak of 9.1% in mid-2022 to 2.9% last month. Both readings are approaching the Fed's 2% target.

Powell sounded confident that the Fed would achieve a so-called soft landing – that is, keep inflation under control without triggering a recession. “There are good reasons to believe that the economy will return to an inflation rate of 2 percent while maintaining a strong labor market,” he said.

Higher interest rates helped contain inflation, as did the removal of supply chain bottlenecks and labor shortages that had led to delivery delays and higher prices as the economy recovered with unexpected strength from the COVID-19 lockdowns.

Interest rate cuts are imminent

Powell suggested on Friday that rate cuts were far from inevitable. “The direction is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the allocation of risks,” he said.

Last year, the Fed predicted it would cut interest rates three times this year, but the cuts were repeatedly postponed as progress in fighting inflation stalled in early 2024. Since then, the steady decline in inflation has resumed, making the Fed more confident that victory was in sight.

Fed misjudged inflation

Powell acknowledged that he and his Fed colleagues misjudged the inflation threat when it emerged in early 2021. At the time, they assumed that the price increase would be short-lived – the temporary consequence of pandemic-related supply chain disruptions. The pressure, they thought, would “dissipate fairly quickly without the need for a monetary policy response – in short, that inflation would be transitory.”

The story continues

They were not alone in their optimism. “The good ship Transitory was well attended,” said Powell, “most of the mainstream analysts and central bankers from the industrialized countries were on board.”

But the word “transitory” came back to haunt the Fed as inflation proved more stubborn than expected, spreading from goods, where supplies were backlogged, to services, where it is harder to get rid of it without raising interest rates and risking severe economic damage in the form of layoffs and higher unemployment. The Fed raised interest rates 11 times in 2022 and 2023.

Unpredictable economy makes politicians humble

Powell acknowledged that policymakers and economists have struggled to understand and respond to an economy that has been unpredictable since COVID-19 hit in early 2020. First, the pandemic shut down commerce and companies collectively cut millions of jobs. Then the economy came back with unexpected vigor, unleashing inflationary pressures that had been dormant since the early 1980s. When the Fed belatedly responded with aggressive rate hikes, economists predicted the cost of hiring would cause a painful recession. But that didn't happen.

“The limits of our knowledge – which have become so clearly visible during the pandemic – require humility and a critical mind that focuses on the lessons of the past and applies them flexibly to our current challenges,” Powell said.