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Opinion With Powell’s rate hike, the inflation fight begins in earnest

Fed Chair Jerome H. Powell on Capitol Hill in September 2020. (Toni L. Sandys/The Washington Post)
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For anyone who wanted proof that this is not the inflation-battered 1970s, Fed Chair Jerome H. Powell just provided it. By delivering the biggest interest-rate hike in almost three decades, Powell has gone a long way to restoring the Federal Reserve’s inflation-fighting reputation — and provided a lesson in how government functions when presidents respect institutions. With the House committee on Jan. 6 reminding us of Donald Trump’s attempt at institution-wrecking, the contrast should be a boon for President Biden.

Sadly, this is politics. Responsibility won’t be rewarded.

Powell’s hike of three-quarters of a percentage point is remarkable for more than its size. As recently as last week, the widespread expectation was that the Fed would raise interest rates by half a point, and the 21st-century Fed has been timidly reluctant to surprise investors. But Powell proved bold enough to administer a shock. So much for the mantra that markets must be coddled.

Powell’s move is all the more impressive because investors were already running scared. As of last Thursday, the S&P 500-stock index was down 16 percent from its peak, with the tech-heavy Nasdaq down even more. Then Friday’s horrible inflation news — the consumer price index is up 8.6 percent from a year earlier — caused investors to begin anticipating additional Fed tightening. That was enough to wipe a further 3 percent off the value of the S&P 500 by day’s end.

Given that reaction, the Fed might have concluded that it could leave the dirty work to investors themselves. The slump in the markets, which has come with a rise in long-term interest rates, means that financial conditions were tightening without the Fed having to change course. But the Fed refused to take this easy path. On Monday, news stories, widely assumed to reflect Fed briefings, began to telegraph an imminent toughening of policy. By the end of trading on Monday, the S&P had crashed a further 4 percent. Still, Powell delivered the tough medicine.

The contrast with the 1970s is stark. Then, after inflation began to pick up in the late 1960s, the Fed did not raise rates with adequate determination until the appointment of Paul Volcker as chairman in 1979. Now, Powell has been late, but only a few months late. To compare him to the dithering Arthur Burns, Fed chairman during much of the 1970s, is absurd.

Sebastian Mallaby: Paul Volcker was the savior our economy needed

Why has Powell been more courageous? The main answer is that Volcker and his successor, Alan Greenspan, created a model of Fed stewardship for later leaders to follow. They proved that the Fed had the ability to quash inflation, something that economists had been prone to question in the 1970s. They demonstrated that the pain of action would only grow larger if the Fed sat on the sidelines.

But the secondary answer is that Powell can be courageous because Biden has supported him. The president has stated, accurately, that “my predecessor demeaned the Fed, and past presidents have sought to influence its decisions inappropriately.” Biden has also promised, “I won’t do this.” By pledging to respect the Fed’s independence, Biden has freed Powell to do the right thing without having to worry that vacant slots on the Fed board will be filled with presidential loyalists who aim to undermine him.

Of course, Powell’s work is far from done, which is why Biden won’t be rewarded for his responsibility. Because inflation is so high, the inflation-adjusted cost of borrowing remains far too low: The Fed will have to hike rates repeatedly. Because unemployment is so modest, upward pressure on wages adds to the wider pressure on prices. To get inflation under control, the Fed will almost certainly have to cause a recession.

No prizes for guessing that this won’t be welcomed. Workers will resent the Fed for deliberately dampening their bargaining power. Savers will blame it for decimating the stocks in their retirement accounts, while forgetting to thank it for protecting their cash from inflation. Already, rocketing prices for gas, cars, electronics and everything in between have hit consumer sentiment, which is at its lowest level since the financial crisis of 2008. Biden’s net approval rating, at minus 14 percent, lags that of all his post-World War II predecessors at this stage in their presidencies.

There is nothing fair about this. Even if the Biden stimulus was excessive and the Fed has tightened late, the size of the inflationary shock reflects a variety of forces beyond Washington’s control: Russia’s invasion of Ukraine, China’s zero-covid lockdowns (and their effect on supply chains), and the sheer unpredictability of the economy’s emergence from a pandemic without modern precedent. Alas, none of these excuses is likely to impress voters. As the 1970s showed, the only thing less popular than inflation is its cure.