Axios AM Deep Dive: Fed blame game

National

Macro

Axios Macro

It is the high season for being mad at the Federal Reserve. Critics accuse them of being feckless as inflation pressures built last year, and as a result, the United States is facing prolonged high inflation, a painful recession to rein it in — or both.

Why it matters: In reality, the Fed didn't create the current inflationary surge by itself — but it was too complacent as prices spiked last year. Now the economic future depends on its ability to make up for lost time, and navigate a tightrope-thin path to bringing inflation down without tanking the economy.

The Fed always takes heat for its decisions. That is to be expected when a handful of technocrats make decisions, behind closed doors, that shape a $24 trillion economy.

Think of it as the Supreme Court, but with no robes and more math.

What is notable is how the most mainstream of economic commentators are piling on. The Economist's recent cover called it "The Fed that Failed." Bloomberg published an essay headlined "The Fed Has Made a U.S. Recession Inevitable" — written by the former president of the New York Fed.

Flashback: Last year, even as inflation started to surge, the Fed kept its aggressive monetary stimulus — interest rates near zero and buying billions of dollars in bonds — in place, only ending it last month.

Insiders at the central bank don't really dispute that they should have begun withdrawing that stimulus earlier. The Fed was lulled by the fact that the initial surge of inflation last spring was concentrated in a handful of categories, then by a temporary softening in inflation last summer.  

"We don't have the luxury of 20/20 hindsight in actually implementing real-time decisions in the world," Chair Jerome Powell said at a news conference last month.

Had they known how persistent inflation would be, Powell added, "then in hindsight, yes, it would have been appropriate to move earlier."

At the same time, it's not clear that inflation right now would be radically different in an alternate universe where they had moved to tighten money earlier. 

"It is unlikely that the Fed could have lowered the inflation rate in 2021 because the fiscal support was so massive and its tools work with a lag," Jason Furman, the Harvard economist and former White House economist, tells Axios.

But by not acting sooner, the Fed has increased the risk that inflation will remain high through 2022, and beyond, he said: “If it had been more aggressive last year, we would be seeing the effects more this year.”

Countries with central banks that did tighten faster are also experiencing high inflation. (In New Zealand, which raised rates back in October, it's 6.9%.)

Moreover, there is a risk that if they had moved more aggressively last year, it would have slowed the rapid recovery without improving the inflation results very much, given the unusual mix of factors around the supply chain disruptions that are driving higher prices.

"I guess, with perfect hindsight, perhaps we would've moved to a contractionary policy stance to try to offset some of the supply chain issues and to offset the strong demand from the fiscal stimulus," Minneapolis Fed President Neel Kashkari tells Axios.

But, he added, "I'm a little bit cautious about saying, 'Boy, we should have just tightened earlier,' because if the inflation's being driven by … supply-side factors, it's not clear what the benefit of that would've been."

Yes, but: The real risk is that by waiting as long as it did to pivot to tighter money, the Fed will have to move so quickly to catch up that it triggers a breakdown, as the economy struggles to adapt to a world of less abundant cash.

When the Fed moves with maximum speed, consumers and businesses have less time to adjust to higher rates on all sorts of debt.

At its meeting that concludes this coming Wednesday, the Fed is likely to begin its catch-up process in earnest by raising short-term interest rates half a percentage point and commencing with shrinking its balance sheet by up to $95 billion a month.

The shift toward tighter money has rapidly spread out across lending markets. The average rate on a 30-year fixed-rate mortgage has soared from 3.11% at the end of last year to 5.10% now.

The bottom line: The Fed spent last year driving their metaphorical car at full speed, not realizing that they were entering a dangerous, curvy stretch of road. The road would still be dangerous no matter what.

The mistake was not slowing down sooner — making for a high risk of crashing. And we're all in the car.

1. The Fed blame game

It didn't create the current inflationary surge, but it was too complacent.

Illustration of hands pointing at one another, collaged with money elements.

Modern Money and Markets

It is the high season for being mad at the Federal Reserve. Critics accuse them of being feckless as inflation pressures built last year, and as a result, the United States is facing prolonged high inflation, a painful recession to rein it in — or both.Why it matters: In reality, the Fed didn&#x27;t create the current inflationary surge by itself — but it was too complacent as prices spiked last year. Now the economic future depends on its ability to make up for lost time, and navigate a tightrope-thin path to bringing inflation down without tanking the economy.

After a record economic expansion, the coronavirus pandemic sent the U.S. economy into a recession as unemployment soared to staggering heights. The country now faces urgent questions about how much stimulus is needed for reeling consumers and businesses, and what a recovery might look like.

Economy & Business

The Federal Reserve has been assigned a task by Congress that is easy to describe, yet fiendishly difficult to achieve. It's known as the dual mandate: to achieve both price stability and maximum employment.

During the high unemployment and low inflation of the 2010s, both parts of that dual mandate pointed in the same direction. Not anymore.

Why it matters: The Fed is in a new world in which it faces more explicit tradeoffs. That will make achieving assigned goals harder — and maybe impossible.

The big picture: The formal, legal language of the mandate comes from the Federal Reserve Reform Act of 1977, which says the central bank must steer credit and money supply "so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."

The part about "moderate long-term interest rates" hasn't been a problem in recent decades, which leaves open the question of what counts as "maximum employment" and "stable prices." The Fed has a great deal of leeway to interpret those goals.

How it works: The central bank now formally defines price stability as an inflation of 2% per year, as measured by the core personal consumption expenditures price index.

This is the part where the Fed is failing. Inflation was up 5.4% over the 12 months ended in February, far overshooting the central bank's target, though by less of a margin than the more widely covered Consumer Price Index.

The definition of "maximum employment" is more squishy. Median official Fed estimates show the longer-run unemployment rate is 4%, though policymakers also emphasize a lot of uncertainty around how low unemployment can go without sparking excessive inflation.

They also think it's better to look at a range of indicators to assess the labor market.

In any event, the view at the Fed at the moment is that the job market is too hot — "tight to an unhealthy level," as Chair Jerome Powell put it in his news conference last month.

Between the lines: Powell and his colleagues are hoping the labor market is so robust they can slow demand just enough that labor shortages and inflationary pressures abate — but employers keep hiring, and the jobless rate doesn't rise much.

It's the equivalent of a double bank shot, where things could go wrong at any step of the way.

What they're saying: "The key insight of the dual mandate is that both sides matter," San Francisco Fed President Mary Daly said in a recent speech. "It was critical to assist the economy in recovering the job losses that occurred early in the pandemic, and it is now critical to stem what has been a longer-than-expected run of high inflation."

Powell has argued that low inflation creates a stable economic backdrop that is good for the labor market. "You can't have maximum employment for any sustained period without price stability," he said at the March news conference.

What's next: Over the coming months, with supply chains stabilizing, fiscal stimulus fading, and the Fed doing its job of slowing demand, there is a good chance inflation will start to come down. 

The question is whether it comes down quickly enough and decisively enough to give the Fed comfort that it doesn't need to cause an outright crash in the job market to speed things along.

The bottom line: The Fed has two jobs, and is currently coming up short at one of them. What is less clear is whether it can fix one side without messing up the other.

2. The Fed has two big jobs, and is failing at one of them

Its dual mandate: achieve both price stability and maximum employment.

Illustration of Jerome Powell and the Federal Reserve building collaged with money elements.

The Federal Reserve has been assigned a task by Congress that is easy to describe, yet fiendishly difficult to achieve. It&#x27;s known as the dual mandate: to achieve both price stability and maximum employment.<ul><li>During the high unemployment and low inflation of the 2010s, both parts of that dual mandate pointed in the same direction. Not anymore.</li></ul>

Axios/Ipsos poll; Chart: Jacque Schrag/Axios

Most Americans are unaware of both goals of the Federal Reserve's dual mandate: stable prices and maximum employment, according to an Axios-Ipsos poll.

Why it matters: It's not surprising that public understanding of the Fed is so low. Most people aren't economists and have lives. But these are the Fed's biggest and most difficult jobs — and the poll shows how little Americans understand or appreciate them.

By the numbers: Fewer than 1 in 10 respondents in our poll knew the Fed is supposed to maximize employment, and only about a third knew it's expected to stabilize prices.

The biggest response in both cases was "don't know" — but about four in 10 answered, incorrectly, that it's false to say the Fed is tasked with maximizing employment.

The big picture: The Fed's approval ratings are low right now, with just 28% saying it does an excellent or good job — down from 38% in March 2021.

Despite the Fed's apolitical nature, its approval ratings are affected by the political divide in the United States — with 39% of Democrats saying it does an excellent or good job, compared to just 17% of Republicans and 27% of independents.

Between the lines: "Don't know" was the most common answer to most questions in our poll. But some people who gave definitive answers assume the Fed has more power than it actually does.

For example, 49% agreed with the statement that the Fed "is responsible for the boom/bust cycles of the U.S. economy."

Nearly a quarter of Americans — 24% — said the Fed controls mortgage rates. In reality, it affects mortgage rates only indirectly.

In other cases, they underestimated the Fed's independence, with 24% saying the president can order the Fed to address inflation. In reality, he can tell the Fed to do anything he wants, but he can't force them to act.

The one Fed action a (slight) majority knew about: 51% knew it increased interest rates in March.

Methodology: This Axios/Ipsos Poll was conducted April 22–25 by Ipsos' KnowledgePanel®. This poll is based on a nationally representative probability sample of 1,015 general population adults age 18 or older.

The margin of sampling error is ±3.4 percentage points at the 95% confidence level, for results based on the entire sample of adults.

3. Axios-Ipsos poll: The Fed knowledge gap

Most Americans are unaware of the Fed's dual mandate goals: stable prices and maximum employment.

Most Americans are unaware of both goals of the Federal Reserve&#x27;s dual mandate: stable prices and maximum employment, according to an <a class="gtmContentClick" data-vars-link-text="Axios-Ipsos poll" data-vars-click-url="https://www.ipsos.com/en-us/news-polls/Axios-Federal-Reserve-2022" data-vars-content-id="b8a2cedf-b697-438f-bbc8-6c1b6ba5f96d" data-vars-headline="Axios-Ipsos poll: The Fed knowledge gap" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.ipsos.com/en-us/news-polls/Axios-Federal-Reserve-2022" target="_blank">Axios-Ipsos poll</a>.Why it matters: It&#x27;s not surprising that public understanding of the Fed is so low. Most people aren&#x27;t economists and have lives. But these are the Fed&#x27;s biggest and most difficult jobs — and the poll shows how little Americans understand or appreciate them.

The vast majority of what the Federal Reserve does on any given day takes place in reserve banks stationed across the country, with an unusual quasi-private structure and wide-ranging, yet below-the-radar, responsibilities. 

Why it matters: The regional Fed banks are facing intense new political pressures, including allegations from conservatives that they have ventured far outside their lane, essentially taking stands on social justice and other issues that undermine the central bank's independence.

If Republicans win one or both chambers of Congress in November, look for an escalation of the attacks — and the possibility of fundamental changes to the century-old political balancing act that distributes the central bank's power across the country.

The backstory: The Fed regional banks' unusual structure makes them the duck-billed platypus of the U.S. government. 

They carry out government policy and are closely overseen by the Board of Governors in Washington, yet they have their own boards of directors comprised of local businesspeople, bankers, and civic figures.

Those boards appoint a president (subject to approval by officials in Washington) who then has a vote in setting interest rate policy at least part of the time.

By the numbers: The Fed Board of Governors had about 2,900 employees in 2020 — while the reserve banks across the country had a combined 18,000. 

Those are the people who spend their days ensuring that the nation's checks clear and electronic payments are fast and secure; supervising banks; and even making sure there is plenty of physical cash available for those banks to fill their vaults and ATMs.

Each reserve bank also acts as something of a regional economic think tank, producing research that informs how its president votes on monetary policy, as well as on matters of particular interest to its community.

But it is this economic research that also is creating controversies — which could have long-lasting consequences.

State of play: The Senate Banking Committee's top Republican, Pat Toomey of Pennsylvania, has accused the reserve banks of "mission creep" in focusing research on areas he sees as outside the Fed's responsibility, including climate change, inequality, and racial justice.

He has sharply criticized the Minneapolis Fed for publishing research on educational inequality and called the banks' efforts to promote those findings essentially taking a side in a Minnesota state ballot initiative on education funding.

He also criticized the San Francisco Fed for research efforts into the economic risks of climate change and racial inequality.

Senate Republican aides have been particularly angered by the Fed's refusal to produce requested documents on these and similar initiatives they view as emblematic of a "woke Fed."

Toomey has threatened to push legislation applying more stringent information disclosure laws on the reserve banks, make their leaders political appointees, or even eliminate or consolidate them.

Fed leaders are at work on new guidance, to be issued in the coming weeks, meant to clarify restrictions on Fed banks' work that could be seen as taking sides in partisan issues and culture wars.

The other side: Some Fed leaders believe one strength of the reserve banks has been that they can research and publish with independence from political meddling. In this telling, it is Toomey and his allies undermining the central bank's independence by trying to make some topics off-limits.

While climate change, education, and inequality may be politically sensitive topics, there is little question they affect the economy.

Neel Kashkari, president of the reserve bank in Minneapolis, tells Axios: "The Minneapolis Fed has done work on education for decades, because education is such an important driver of employment outcomes and maximum employment."

"It's a research topic for us," he added. "So as long as what we're doing is non-partisan, and it's grounded in our research, and it's related to our mandate, our board of directors feels very strongly that we should be making a contribution if we can."

Yes, but: While the reserve banks are currently under attack from conservatives, they have more typically been attacked by liberals, who view them as undemocratic and overly representative of business and banking interests.

For example, since 2000 there have been 57 dissents by Fed regional bank presidents on monetary policy in a hawkish direction — preferring tighter money — versus 15 toward looser money.

Moreover, reserve bank presidents tend to serve longer and be less political than presidential appointees, contributing to Fed independence. Outgoing Chicago Fed president Charles Evans, for example, is a career public servant who was in that role through four presidents (Bush, Obama, Trump, Biden) of both parties.

4. Fed regional banks face charges of politicization

Some conservatives say they've ventured far outside their lane.

Abstract illustration of bits of money and a tilted scale of justice. 

The vast majority of what the Federal Reserve does on any given day takes place in reserve banks stationed across the country, with an unusual quasi-private structure and wide-ranging, yet below-the-radar, responsibilities. Why it matters: The regional Fed banks are facing intense new political pressures, including allegations from conservatives that they have ventured far outside their lane, essentially taking stands on social justice and other issues that undermine the central bank&#x27;s independence.

Data: BLS via FRED, FreddieMac, FactSet; Charts: Jacque Schrag/Axios

5. The Fed's impact in 4 charts

If you don't spend your time parsing monetary policy statements or listening to Federal Reserve chair Jerome Powell's dulcet tones, much of the terminology you hear from the Fed will seem unfamiliar and strange. We're here to help.

Why it matters: The Fed has a jargon all its own, but this guide can help you understand it. 

The following quotes are from Powell's March news conference after a meeting of the Federal Open Market Committee — the group that sets U.S. monetary policy.

When they say: "Against the backdrop of an extremely tight labor market and high inflation, the Committee anticipates that ongoing increases in the target range for the federal funds rate will be appropriate."

They mean: Yeah, yeah, we know that raising interest rates by a piddly quarter-percent isn't enough to stop this inflation. But we are on top of it. So we're going to keep on raising the overnight bank lending rate we control. Buckle up, borrowers.

When they say: "The labor market has continued to strengthen and is extremely tight."

They mean: That whole "maximum employment" thing Congress has assigned us to take care of? Mission accomplished. In fact, we may have over-torqued it a bit. So when you can't find a waiter at your favorite restaurant because of labor shortages, that's at least a little bit on us.

When they say: "The median inflation projection of FOMC participants is 4.3% this year and falls to 2.7% next year and 2.3 percent in 2024; this trajectory is notably higher than projected in December, and participants continue to see risks as weighted to the upside."

They mean: We think the rate increases we're planning will be enough to get inflation down, but we have no idea how long that's going to take. And we're nervous that inflation will be higher than we expect, rather than lower.

When they say: "The Committee made good progress on a plan for reducing our securities holdings, and we expect to announce the beginning of balance sheet reduction at a coming meeting."

They mean: Yes, sure, we stimulated the economy by buying up $5 trillion in bonds since the pandemic began — and only stopped buying 10 minutes ago — and maybe we overdid it a little. But we're going to get on with reversing that process real soon, we promise.

When they say: "We will need to be nimble in responding to incoming data and the evolving outlook. And we will strive to avoid adding uncertainty to what is already an extraordinarily challenging and uncertain moment."

They mean: Look, don't think too hard about the contradiction here. We want to be nimble — ready to turn policy on a dime — but also be predictable so we don't contribute to uncertainty. As a wise man once said, 🤷‍♂️.

6. A quick and easy guide to Fedspeak

Illustration of a man in a suit speaking, with money elements overlaid on the image.

If you don&#x27;t spend your time parsing monetary policy statements or listening to Federal Reserve chair Jerome Powell&#x27;s dulcet tones, much of the terminology you hear from the Fed will seem unfamiliar and strange. We&#x27;re here to help.Why it matters: The Fed has a jargon all its own, but this guide can help you understand it.

Good afternoon, and welcome to the first installment of our new Modern Money & Markets Deep Dive series. This edition is a guide to how the Federal Reserve really works, led by Axios chief economic correspondent Neil Irwin.

Sign up for Axios Markets, Axios Capital and Axios Closer.

The first installment of our new Modern Money & Markets Deep Dive series.

Photo illustration of money elements and the Federal Reserve building.

Photo Illustration: Shoshana Gordon/Axios. Photo: Saul Loeb/AFP via Getty Images