Opinion: Many have lost faith in the Fed. Will he be able to earn our trust again?

This unfortunate state of the Fed — damned if you do and damned if you don’t — is indicative of a deeper issue. Having missed the window when a “soft landing” for the economy was feasible (ie lowering inflation without much damage to the economy), the Fed now finds itself far removed from the world of “primary” policymaking. In other words, instead of having highly effective, timely, and appropriate measures to combat inflation, this Fed has ended up in a world where almost every policy action it takes can cause significant collateral damage and unintended consequences. Many politicians, businesses and households risk thinking of the Fed as part of the problem and not part of the solution.

It is likely to be a record third consecutive increase of 75 basis points on the back of damaging cost-of-living increases that have been widening in scope and, to make matters worse, becoming more embedded in the fabric of the economy. Core inflation, currently at 8.3%, is falling, but the core rate, which excludes more volatile categories like food and gas, is still rising. And it is the latter, currently at 6.3%, that measures the extent and probably duration of inflation.

However, for almost all of last year, the Fed steadily reduced the threat of inflation. Meanwhile, the economy continued to be conditioned to operate under a zero interest rate; and markets continued to be comforted by the Fed’s repeated interventions to offset falling stock prices (the so-called “Fed Put”).

But until the end of November last year, the Fed did not stop, time and time again, ensuring that inflation was “transient”. Just a few months ago, it was still pumping liquidity into the economy while inflation was rising rapidly.
Now, the Fed realizes that it was too late to respond. By allowing inflation to become more embedded — or, as Chairman Jerome Powell put it last month, “spread throughout the economy” — the Fed must be far more aggressive now than it would have been if it had responded in time. The Fed must avoid another blow to its already damaged reputation and policy credibility.
Opinion: The Fed needs to see 3 things before it stops hiking rates
Instead of leading the markets in fighting inflation, the Fed has been forced to follow them. Until Powell’s hawkish pivot at the Jackson Hole Economic Symposium, he was repeatedly forced to revise policy guidance to make it more consistent with what the markets indicated. Coupled with seemingly endless one-way revisions to key economic forecasts (higher inflation and lower growth), this has sadly changed the Fed’s economic and financial role from trusted leader to laggard.

However, since it is too late to respond, the Fed will move to a weakening domestic and global economy. Thus, there are more and more economists warning that the Fed will lead the US into recession; and more and more foreign officials believe that the world’s most powerful and systemically important central bank is pulling the rug from under an already fragile global economy. This is a far cry from the Fed’s famous role in helping avert very damaging global depressions in 2008-2009 and more recently in 2020.

This week’s policy action could end up in three different parts of our economic history books: The Fed raises rates by 75 basis points for the first time in three consecutive meetings; Another component of the central bank’s biggest mistake in decades; and an unusual example of a central bank in a developed country finding itself in a policy hole more familiar to its counterparts in developing countries.