WASHINGTON (AP) – Federal Reserve Chairman Jerome Powell fears that a too low inflation rate may linger for a while, thus weakening the US economy.
Powell's concern is one of the main reasons the Fed will likely reduce interest rates in the near term later this month for the first time in a decade: a reduction in rate – and especially if followed by others – could help bring inflation closer to the Fed's target level.
The President's recent concerns about chronically low inflation reflect yet another radical change in the Fed: Powell and other officials seem to have abandoned the usual economic rule that a long wave of low unemployment would inevitably result in too much inflation .
The US unemployment rate remained below 5% for about three years. And yet, annual inflation has still not reached the 2% target set by the Fed.
All of this suggests that the Fed is now willing to maintain indefinitely the cost of borrowing for households and businesses – even though the labor market and the economy continue to grow steadily. This is a prospect that has delighted investors, who have raised the stock market indexes to unprecedented highs.
"The link between unemployment and inflation was very strong if we went back 50 years, and it was getting weaker and weaker," said Powell at Capitol Hill this week. , in response to questions from Rep. Alexandria Ocasio-Cortez, a New York Democrat. "We really learned that the economy could maintain a much lower unemployment rate than expected without creating inflation problems."
Kathy Bostjancic, an economist at Oxford Economics, a consulting firm, said Powell's comments marked a turnaround from last year. The FED had partly justified its four rate hikes in 2018 by explaining that a robust hiring would eventually trigger inflation.
"Their thinking has changed a lot," Bostjancic said. "The Fed has been slow to this idea."
Generally, in the past, when unemployment had fallen to a very low level – as is currently 3.7% – employers are forced to offer higher wages to attract and keep the workers. These employers, in turn, raise prices to offset the cost of their higher wages.
Yet this dynamic, which economists call the "Phillips curve," has not yet occurred during the decade of growth. Consumer inflation in June, for example, rose only 1.6% in June from 12 months earlier, a level below the Fed target.
Of course, most Americans prefer low prices. But the Fed has reason to worry when inflation remains consistently below its target level. Their main concern is that when businesses and consumers expect inflation to be kept at extremely low levels of inflation, they consider them in decisions such as how much they are willing to spend or increase their wages. Why spend or pay more now if prices are not likely to go up or down?
Powell warned on Wednesday that such low expectations are rooted, which is difficult to dislodge. The central banks of Japan and Europe have reduced their interest rates in negative territory – which means that state bondholders are losing money – in the desperate efforts to accelerate growth and prices.
"You do not want to fall behind and let inflation fall below 2%," Powell said Wednesday before the Senate Banking Committee, the second of his two-day testimony.
However, according to the Fed's preferred inflation gauge, it has been below 2% for almost seven years since the central bank chose this target.
At the May 1 press conference, Powell described the drop in inflation since the beginning of the year as a "spike", with trends such as falling clothing prices. But in his testimony before Congress this week, he acknowledged "the risk that inflation will be weak and even more persistent than expected".
Economists point to a series of factors that keep inflation at extremely low levels. Globalization has enabled the production of many goods in low-wage countries, thus reducing costs. The so-called "Amazon effect" of online shopping, which allows for real-time price comparisons, has made it difficult for retailers to charge more.
Fewer workers belong to unions and therefore have less bargaining power to demand higher wages. And by some measures, the US labor force is, on average, less efficient: productivity growth, which measures output per hour worked, has remained notoriously low during expansion. This has prompted companies to increase their wages.
Powell and other Fed officials have expressed the hope that a rate cut would make it cheaper to borrow and buy a house or car or to do business. 39, other purchases, which would accelerate the economy. Faster economic growth could push inflation up, at least slightly.
Higher inflation offers some advantages. This helps to lubricate the workings of the economy: people are more likely to buy something they worry that it will cost more later. Businesses are more likely to raise their wages to cope with higher prices, making debt repayment easier.
Nevertheless, further Fed rate cuts carry risks: some Fed officials warned at its last meeting in June that a rate cut could help fuel a bubble in the stock market. This is because lower interest rates would likely encourage more and more investors to abandon low-yield bonds and seek higher equity returns.
But overall, there is a rare bipartisan agreement on the need for the Fed to lower its benchmark rate.
Larry Kudlow, one of the White House's top economic advisers, congratulated Ocasio-Cortez of Fox News Channel's Fox & Friends for challenging Powell's Fed belief that a low unemployment rate would accelerate the pace of the economy. ;inflation.
"I have to get rid of the situation – Mrs AOC has somehow nailed the problem," conceded Kudlow.