**August 26, 2022**
**Monetary Policy and Price Stability**
**by Chair Jerome H. Powell**
**Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy. Committee participants' most recent individual projections from the June SEP showed the median federal funds rate running slightly below 4 percent through the end of 2023. Participants will update their projections at the September meeting....**
**That brings me to the third lesson, which is that we must keep at it until the job is done. History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting. The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.**
**These lessons are guiding us as we use our tools to bring inflation down. We are taking forceful and rapid steps to moderate demand so that it comes into better alignment with supply, and to keep inflation expectations anchored. We will keep at it until we are confident the job is done....**
Powell clearly says that the Fed will keep the fed funds rate above the “neutral” rate. Powell said, “At our most recent meeting in July, the FOMC raised the target range for the federal funds rate to 2.25 to 2.5 percent, which is in the Summary of Economic Projection’s (SEP) range of estimates of where the federal funds rate is projected to settle in the longer run.” This shows that the Fed does not plan to return to the zero fed funds rate that shoveled immense, unprecedented amounts of fiat money at negative real yields into the asset markets for most of the time since 2008.
If the Fed actually follows through on this strategy, it’s a generational trend change. Asset prices have been settled with the assumption that negative rate lending and the Fed “put” (where the Federal Reserve immediately cuts the fed funds rate whenever the stock market drops) will continue indefinitely into the future.
A Fed study showed that 10% of listed companies are “zombies” which can barely make the interest payments on their debts but don’t have enough cash flow to pay them off. The debts must be rolled over (refinanced) when they mature. If interest rates rise for the long term, many of these companies may default.
Only the unprecedented flood of money has enabled the unprecedented rise in all asset prices – stocks, bonds and real estate. I don’t expect the Fed to withdraw this money (e.g. by selling its huge book of Treasury and mortgage bonds quickly) but it takes continuous pumping to achieve continuous growth.
The sudden rise in mortgage rates over the past 6 months shows what happens without continuous pumping. They have returned to almost the same rate as the pre-2008 rate.
IF the Fed has actually changed strategy – IF they intend to return to an economically neutral role, fulfilling their mandates* but not pumping the asset markets, it is the biggest trend change since the 2008 financial crisis.
That’s a big IF. The near-term trend change will be a drop in the asset markets with temporarily higher rates. The longer-term rates (and stock valuations) won’t change much unless the market is convinced that the Fed has truly changed its fundamental mode from stimulative to neutral. But IF the Fed does go from stimulative to neutral in the long term – watch out. Asset valuations will eventually return to the historic average if they do.
*The Fed’s dual mandate is price stability and maximizing employment to the point that wage inflation doesn’t result.