WEEK AHEAD

"The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably down toward 2 percent. Of course, we are committed to both sides of our dual mandate, and an unexpected weakening in the labor market could also warrant a policy response. We will continue to make our decisions meeting by meeting."

—Chair Powell's FOMC Press Conference, March 20, 2024.

Assessing the Fed – Lessons Learned or New Paradigm

In the realm of economic policy, where the Federal Reserve wields its Keynesian toolkit like a seasoned craftsman, a recent departure from convention has set eyes wide open on Wall Street. Chairman Jerome Powell's latest address, delivered post-Federal Open Market Committee (FOMC) meeting, wasn't your run-of-the-mill monetary policy sermon. No, it was more akin to a riveting academic debate, with Powell spotlighting an unexpected protagonist: "It is different this time."

Gathered at the esteemed Stanford Graduate School of Business, Powell's discourse veered into uncharted territory, hinting at a potential rendezvous with economic theory's less favored sibling. Could it be that the Fed's playbook needs an unconventional rewrite in the face of post-COVID inflation woes?

Traditionally, the Fed's dance with interest rates has been a delicate ballet aimed at steering aggregate demand, the cornerstone of demand-side economics. But despite unleashing a barrage of 11 rate hikes between 2022 and 2023, intended to apply the brakes on demand, the economy remains as buoyant as a helium-filled balloon at a parade. GDP growth struts along at a robust 3.4%, and unemployment lounges comfortably at 3.8%, leaving economists scratching their heads and their models gathering dust.

According to Powell, "So what is actually different this time, at the risk of making that statement, is that this inflation wasn't strictly just a question of demand overheating and the Fed coming in and having to suppress demand. That's been the more typical pattern perhaps on the back of a shock such as oil price shock, that kind of thing."

To their credit, Powell and his FOMC cohorts acknowledged the unexpected plot twist. This time around, it seems, the economic narrative has taken an unexpected turn, catching the Fed unprepared and leaving traditional economic theory in the dust – overheated demand and low-interest rates.

 "This episode actually also involved, as everyone will recall, the collapse of the supply side in a lot of ways. Supply chains stopped working. There were shortages of critical things like semiconductors, and it turned out that you couldn't make cars. In addition, there was a major labor force shock, so we lost several million people out of the labor market, causing a very severe labor shortage. So, it was a supply-side issue as well as overheated demand from the closing and then the reopening of the economy at a time when rates were low and fiscal policy was very supportive of demand," said Powell.

The market's anxious expectations of a rate reduction might have been premature. 

"So we had both of those things and therefore if those were the causes, what we needed to see was both the unwinding of the pandemic-related distortions to both supply and demand in the economy and the tight effects of monetary policy. So, today what we think we are seeing as inflation has come down sharply over the last year, is those two factors working together. They do work together, we think tight monetary policy weighing on demand that gives the supply side a better chance to recover," explained Powell.

Powell's narrative suggests that while demand may be frothy, the supply side of the equation is throwing the biggest curveballs. It's as if the economy decided to break free from its traditional narrative arc and pen its own script, leaving the Fed scrambling to rewrite the ending.

But as the curtain falls on Powell's performance, one can't help but wonder if a subplot has been overlooked. Could the Fed be missing a crucial clue in their quest to restore equilibrium? After all, in a world where intangible assets like software and A.I. are rewriting the rules of the game, perhaps it's time for the Fed to extend its approach.

As Bill Gates quipped, "the portion of the world's economy that doesn't fit the old model just keeps getting larger." Perhaps it's high time for the Fed to embrace the chaos and uncertainty of this new economic landscape, lest they find themselves playing a starring role in the next great recessionary drama.