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Jerome Powell has said repeatedly that the Fed’s goal is to get rates higher and leave them there for an extended period of time. He believes that the mistake of the 70s was that once higher rates snuffed out inflation, the Fed cut rates too quickly and the inflation returned. I think the mistake of the 70s was that, by overtightening, the Fed created a deep drop in economic activity that necessitated the subsequent rapid cuts. And if today’s Fed doesn’t slow down the pace of their hikes, they risk repeating the same mistake as the 1970s-era Fed. If the Fed wants to raise rates and keep them there, they need to act conservatively and avoid overtightening.

At last week’s post-FOMC press conference, Powell had this to say about potentially overtightening:

If we over-tighten, then we have the ability with our tools, which are powerful, to—as we showed at the beginning of the pandemic episode—we can support economic activity strongly if that happens, if that’s necessary. On the other hand, if you make the mistake in the other direction and you let this drag on, then it’s a year or two down the road and you’re realizing—inflation, behaving the way it can—you’re realizing you didn’t actually get it; you have to go back in. By then, the risk really is that it has become entrenched in people’s thinking.

I don’t think those tools are actually as powerful as he thinks they are because he and his predecessors have overused them. But more importantly, how can he not see the parallel with the 1970s? Hiking too fast, not allowing time to see the effect of past rate hikes, is exactly how the Fed ends up overtightening in just about every cycle. It isn’t the level of rates that has the biggest impact on the economy, it’s the rate of change. Interest rate and exchange rate volatility, which are obviously interrelated, are large impediments to business planning and investment. A company can hedge those risks of course, but, oh by the way, the cost of hedging rises with the volatility created by the Fed.

The Fed’s constant tinkering with interest rates adds volatility and uncertainty to the business investment equation. It can, therefore, be credibly argued that the Fed’s constant interventions lower long-term economic growth. Is that an acceptable trade-off? It might be if they were successful in stabilizing inflation. But they aren’t. Inflation ran below their target for the vast majority of the last decade and is now running way above target. Their interventions have failed. Repeatedly. Under various FOMC formulations and chairpersons. This is not solely a Jerome Powell problem; the real issue is interest rate targeting.

The Fed – and all central banks – needs to do less, not more. They need to act conservatively, reluctantly. If not, they’ll just repeat the boom/bust cycle so of the 1970s. I have little confidence that Jerome Powell can avoid that outcome except through shear luck.

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