Could Inflation Drive Powell to Act Like Volker?

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Could Inflation Drive Powell to Act Like Volker?

The war in Ukraine threatens to make the costs last longer. Gas prices have already risen, leading to headline inflation as consumers pay more at the pump. Disruptions in supply chains – and reductions in Russian and Ukrainian exports such as neon, palladium and wheat – could reduce car and food production and transport of goods, exacerbating global shortages.

Now, fresh virus restrictions in Shanghai and Shenzhen, China, a major technology manufacturing hub and port city, are increasing the risk of supply chains breaking down in the coming months. These shocks from outside come at a time when price pressures had already started spreading to categories like rent, another development that could make inflation last.

It’s not clear whether those factors will keep inflation high, but Fed officials will be watching carefully.

If the Fed were to raise interest rates to painful levels to cool the economy and put a lid on prices, it could plunge financial markets, wiping out stocks and housing assets. It can slow wage growth and throw people out of jobs as companies cut back on layoffs, investments and recruitment.

But Fed inaction – or under-action – will also carry risks. High prices that reduce consumers’ ability to buy electricity year after year make it difficult for families and businesses to plan for the future. They can especially hurt people who are out of work and living on savings, or the poor, who devote a large portion of their budget to necessities and if costs spiral out of control. So there is less room to cut.

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Mr Volker, Mr Powell’s predecessor, one of his professional idols, and – potentially, if things go wrong – died in 2019. But he had trade-offs to consider.

Mr Volcker wrote in his 2018 memoir that maintaining the belief that a dollar can buy tomorrow what it is today is “a fundamental responsibility of monetary policy”. “Once lost, the consequences can be dire and it can be difficult to restore stability.”

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