The Economy: If it Dies, it Dies

Jerome Powell is now channeling the spirit of Paul Volcker:

(JP’s comments made at a Wall Street Journal event Tuesday)

“What we need to see is inflation coming down in a clear and convincing way and we’re going to keep pushing until we see that. If we don’t see that, we will have to consider moving more aggressively.”

“Achieving price stability, restoring price stability, is an unconditional need. Something we have to do because really the economy doesn’t work for workers or for businesses or for anybody without price stability. It’s the bedrock of the economy really.”

“If that involves moving past broadly understood levels of ‘neutral’ we won’t hesitate to do that. We will go until we feel we are at a place where we can say ‘yes, financial conditions are at an appropriate place, we see inflation coming down.’”


Inflation is now the Fed’s number one enemy. And they have the tools to fight this battle. I don’t know if they’ll win, but they’re starting to appear willing to body-slam the economy if that’s what it takes.

The trouble is that the Fed’s policy tools only target aggregate demand. They’ll suck out liquidity and make money expensive to force people and companies to spend less. As a corollary, the negative wealth effect created by falling asset prices will also further weaken demand. Weaker demand will ease pricing pressures to an extent.

What the Fed can’t fix is supply constraints. They can’t compel supply chains to heal and companies to produce more. In fact, by making money more expensive the Fed is forcing companies to cut back investment in productive capacity, amplifying supply constraints.

It’s possible that weaker aggregate demand might be enough to tenderize inflation. But what if it’s not?

To get close to the target inflation rate of 2%, the Fed might need to cut demand so much that today’s undersupply becomes tomorrow’s oversupply. Nobody really knows where aggregate demand and supply intersect so in reality Powell will need to keep tightening the screws until it’s clear that inflation is getting close to target.

Will the Fed go too far? You’re damn right they will.

I’ve previously shown that the rate of inflation might be softening a bit. However, inflation remains dangerously high and is becoming a major economic, social and political problem.

Inflation simply must be tamed. Taking Jerome Powell at his word, if his first moves don’t work he’ll keep inching his knife through the economy’s chest. If aggregate demand must be dragged below current supply levels to affect inflation, so be it. If the economy dies, it dies.

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