The Fed and the High-Pressure Economy

Nearly 50 years ago (Spring 1973) Arthur Okun wrote an important article for Brookings entitled “Upward Mobility in a High-Pressure Economy.” (See: https://www.brookings.edu/bpea-articles/upward-mobility-in-a-high-pressure-economy/ ) It seems to me that the Fed is seeking such an environment where the economy is operating at or above its potential level of output to light a fire underneath the labor market. That is a worthy goal, but the last time it was tried it ended with unfortunate inflationary consequences.

 

Chair Powell’s concern about the labor market explains his reluctance to put specific numerical guideposts on the Fed’s plan to exit from its emergency monetary policy established in March 2021. Thus, in his July 14^th testimony before Congress, Powell used the term “substantial further progress” on reaching its maximum employment and 2% inflation goals without defining it. 

 

Inflation is already running well above 2% and likely to be far from transitory and the BLS just reported that the unemployment rate dropped to a recovery low of 5.4% in July. To be sure total employment remains far from its February 2020 peak, but many workers have permanently left the workforce due to retirement and lifestyle choices.

 

Although the Fed will make verbal moves to start the tapering process either at the upcoming Jackson Hole meeting or the September FOMC meeting, my guess is that it will drag its feet when it comes to actually implementing a meaningful tapering program. Simply put the Fed is running an experiment to how hot it can run the economy before inducing a significant rise in inflation expectations. My guess we are a lot closer to that than what the Fed thinks. Meantime monetary policy will remain easier than what is warranted and that along with strong corporate earnings will continue to elevate stock prices.