Aug 26, 2019

The escalation of the trade war may be too much for the Fed

Dion Rabouin, author of Markets

Illustration: Lazaro Gamio/Axios

In his speech at Jackson Hole on Friday Fed Chair Jerome Powell effectively acknowledged that the world has reached the end of monetary policy as we know it.

What's happening: While central banks could rest assured they had the tools to rein in inflation and unemployment in the old days, that's now uncertain in this new world.

Why it matters: Central bank policy was the biggest factor in pulling the global economy out of the financial crisis in 2009 and has been the primary force driving markets for the past decade.

  • Central banks are cutting interest rates at a pace not seen since the crisis in an attempt to stave off the global economic slowdown that's been picking up speed this year, but it may be futile.
  • The escalation of the trade war is exacerbating already troubled and highly indebted economies in Europe, Japan, China and elsewhere.

The big picture: Powell's speech was a daunting admission that the all-powerful Federal Reserve may be powerless to stop a recession if it reaches the U.S. — at least with its current box of tools.

  • There are “no recent precedents to guide any policy response to the current situation," Powell said Friday, referencing the trade war.

Between the lines: Worry about the waning impact of monetary policy was also recently voiced by former Treasury Secretary and National Economic Council head Larry Summers.

  • Summers notes in a piece with co-author Anna Stansbury that there are "strong reasons to believe that the capacity of lower interest rates to stimulate the economy has been attenuated — or even gone into reverse."
  • Worse, they argue that in recent years additional government spending also has proven less effective at boosting the economy.

The last word: "As we look back over the decade since the end of the financial crisis, we can again see fundamental economic changes that call for a reassessment of our policy framework," Powell said at Jackson Hole.

  • "To address this new normal, we are conducting a public review of our monetary policy strategy, tools, and communications — the first of its kind for the Federal Reserve ... and we are asking whether we should expand our toolkit," Powell said.

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