Inflation Persisted Because the Fed Relented
The FOMC Played with Fire and Now They're Getting Burned
“Common sense I believe is the most valuable possession anyone can have. Such success as I have had in life has been due to it, and to the fact that I was not afraid to use such common sense as God gave me.”1
—HETTY GREEN, the Queen of Wall Street (July 18, 1897)
The Museum of American Finance’s Winter 2025 issue of Financial History will feature an article detailing the unappreciated values of Hetty Green. If you never heard her name, it is unsurprising. Hetty Green was modest by nature and, therefore, left no monuments to glorify her conquests on Wall Street.
Among Hetty Green’s many impressive skills was her ability to sense the ebbs and flows of the monetary tides. This enabled her to amass massive cash reserves well in advance of market panics, which frequently tormented denizens of Wall Street around the turn of the twentieth century. In a rare interview conducted on July 18, 1897 with a journalist from The Saint Paul Globe, Hetty Green listed common sense as her greatest virtue. Sadly, it appears that common sense is in short supply at the Federal Reserve in 2024.
An Ill-Advised “Recalibration” of Monetary Policy
Note: The Whip Inflation Now (WIN) program which was launched in 1974 was an attempt by President Gerald Ford to tame inflation by encouraging consumers to alter their spending and savings habits. It is now counted among one of the federal government’s worst public relations blunders.
On August 23, 2024, Chair Jerome Powell used his annual speech at Jackson Hole to send a clear message that the Federal Reserve intended to pivot toward less restrictive monetary policy. In the newsletter published on August 27th, I explained why financial history strongly suggested that this decision was premature. Then, on September 18, 2024, the FOMC cut the federal funds rate by 50 basis points, projecting a high-level of confidence that post-COVID-19 inflation would continue on a path to the Fed’s long-term target of two percent. In the newsletter published on October 10th, I explained why financial history strongly suggested that such confidence was unwarranted, and that this decision constituted a big policy error.
Sure enough, over the subsequent months, inflation data remained stubbornly high, while labor markets and economic growth remained strong. This put the FOMC in an unenviable position. They had painted themselves into a corner by expressing confidence in a plan to enact further rate cuts through the remainder of 2024 and throughout 2025. Backtracking after only a few months risked spooking the markets. Therefore, rather than admitting an error, the FOMC sprinted down the inflationary gauntlet hoping to somehow emerge unscathed.
On November 7th, the FOMC enacted a 25-basis-point cut to the federal funds rate. Then, on December 18th, the FOMC announced another 25-basis-point rate cut. In the post-meeting press conference, Chair Powell suggested that the “recalibration” was completed—or at least nearly completed. But just like labeling inflation “transitory” in 2021 proved to be short-sighted, financial history, most current data, and a healthy dose of common sense strongly suggests that the Fed’s recalibration will not go according to plan.
A Press Conference Full of Mixed and Misleading Messages
“If you can’t understand what the professor is saying, don’t dismiss the possibility that he might be wrong.”2
—PAUL A. VOLCKER, former chairman of the Federal Reserve
Chair Powell’s press conference was a masterpiece of mixed and misleading messages. I was physically uncomfortable watching him grasp at straws to defend a policy that is indefensible. He attempted to rationalize the continued easing of monetary policy despite a preponderance of data—not to mention powerful historical precedents—that indicate it was a mistake. Not only did Chair Powell fail to present a convincing case, but he also cited data that contradicted his own argument. Below, I highlighted three examples that seemed especially misleading and/or illogical.
Monetary Policy is “Meaningfully Restrictive”
On several occasions, Chair Powell described the current federal funds rate as “meaningfully restrictive.” The problem is that even back-of-the-envelope math suggests that it is roughly neutral—and perhaps even slightly accommodative. Thomas Hoenig, former president of the Federal Reserve Bank of Kansas City made this point in a post-meeting interview with Kathleen Hays of Central Bank Central. Moreover, regardless of whether the Fed believes current policy is restrictive, the actual data on labor markets, prices, valuations of risk assets, and long-term bond yields clearly indicate that monetary policy is not restrictive enough.3
Long-Term Inflation Expectations Are Well-Anchored
Some journalists at the press conference expressed concern about rising inflationary pressures. Chair Powell attempted to ease their concerns by claiming that long-term inflation expectations are well-anchored. It is unclear whether this is true, but even it is true, expectations are anchored in a bad place. For example, the University of Michigan survey has consistently revealed that median five-year inflation expectations remain slightly above 3% (see figure below). Moreover, inflation expectations have increased slightly since the Fed announced its pivot in August 2024. In other words, five-year inflation expectations are well-above the Fed’s two percent target, and it seems quite plausible that they are headed in the wrong direction. Even if one gives Chair Powell the benefit of the doubt and concedes that inflation expectations are “well-anchored,” they are moored in dangerous waters.
Current Monetary Policy Balances the Risks of Price Stability and Maximum Employment
Chair Powell stated that current monetary policy balances the risks to price stability and potential weakening of labor markets. Nothing could be further from the truth. Using the Fed’s own data and projections from the SEP, inflationary pressures have risen meaningfully since the August 2024 pivot. Moreover, labor markets strengthened, and unemployment remains steady at slightly above four percent. Many economists would argue that this unemployment rate is consistent with full employment. Given the imprecision of estimating the natural rate of unemployment, it is also quite conceivable that the U.S. is operating below the rate of full employment. Cutting rates multiple times in the face of a strong labor market, strong economy, and rising inflationary pressures is precisely the opposite of what the Fed should be doing. In other words, the FOMC’s concerns are squarely biased toward supporting labor markets despite the fact that current data and compelling lessons from history overwhelmingly support adopting a strong bias toward price stability.
The Fed Needs to Stop Torturing the Data and Open Their Eyes
“Faced with the choice between changing one’s mind and proving that there is no need to do so, almost everybody gets busy on the proof.”
—JOHN KENNETH GALBRAITH
In August 2024, Chair Powell and the FOMC made a clear commitment to easing monetary policy despite compelling historical evidence that it was premature. As a result, inflationary pressures have strengthened while pressure on labor markets has weakened. This outcome was both foreseeable and preventable.
In the late 1960s and early 1970s, the Fed abandoned monetary policy tightening prematurely on several occasions, which allowed inflationary pressures to reignite at incrementally higher levels. Americans suffered seventeen years of stagflation as a result. The Great Inflation of 1965-1982 ended only after Chairman Paul A. Volcker courageously instituted draconian monetary policies, forcing a painful recession. The key lesson was that central bankers must extinguish inflation promptly and decisively if a similar situation were to arise in the future.
Chair Powell and the FOMC ignored this lesson and then dismissed a barrage of data warning them that they were repeating the mistakes of their predecessors. The FOMC leadership knew or should have known that abandoning tight monetary policy prematurely was likely to produce a similarly undesirable outcome. It is patently unsurprising that it did.
Chair Powell has damaged the Fed’s credibility by allowing the FOMC to intentionally dump gasoline on the inflationary embers. Any future claims that the Fed is a victim of unpredictable circumstances will ring hollow in the halls of financial history. The Federal Reserve is not dealing with an unprecedented event—they have simply ignored past precedents and will now pay the price.
Learn More about Financial History
The insights in this newsletter draw from my recently published book, Investing in U.S. Financial History: Understanding the Past to Forecast the Future. The book can be purchased by clicking on the cover below.
Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.
Carpenter, Frank G. “A Chat With Hetty Green.” The Saint Paul Globe, 18AD.
Paul A. Volcker and Toyoo Gyohten. Changing Fortunes: The World’s Money and the Threat to American Leadership. (New York: Times Books, 1992).