Federal Reserve Chair Jerome Powell on Thursday said the central bank’s interest rate hikes still have more work to do, pointing to evidence that the policy moves haven’t had their full impact on inflation.
Powell, in testimony to the Senate Banking Committee, acknowledged that inflation has roughly halved in the past year but attributed that in large part to lower energy and food prices.
“I won’t say [food and energy are] not affected at all by monetary policy, but they’re principally affected by other things in the economy,” he said, including fallout from the war in Ukraine. He also said prices have cooled as supply chain snarls have eased. “That, again, is not really a function of monetary policy.”
The most recent Consumer Price Index reading showed that annual inflation came down to 4 percent in May, from a peak of over 9 percent last summer. The extent to which price spikes continue to lessen will be a key determinant of whether the Fed needs to force a recession to tame the rising cost of living. Officials are closely watching the labor market, as wages are one of the biggest expenses for key service sectors that are seeing large price increases.
“Really, where monetary policy takes effect is in the service sector, and that’s where we haven’t seen much progress,” Powell said. “Inflation, broadly, is coming down, but as I said in my remarks, we still have a long way to go. Inflation’s still running between 4 and 5 percent.”
Here are more takeaways from the hearing:
Rate hikes take a while to affect inflation
Powell, under questioning from Sen. Bob Menendez (D-N.J.), said he didn’t think rate increases were less effective but that they merely take a while to fully do their job. How long? A year is a decent guess, he said.
“This day and age, financial conditions react before we act. So the markets are already pricing in rate hikes, so that’s quicker,” he said. Mortgage rates, for example, jumped rapidly as the central bank ramped up its plans to raise borrowing costs, which it began to do in March 2022.
But the full impact of those financial conditions on the economy takes time. “It works very quickly on housing for example, but less so on the service sector, which is not very interest-sensitive.”
There is considerable disagreement among economists about how long it takes for the Fed’s actions to feed through to economic activity and ultimately inflation. “A year and change – that’s not a bad way to look at it,” Powell said. “But policy actually started tightening well before that.”
A proposal to toughen bank rules is not finished yet
Big banks are expecting within the next few weeks a proposal from their regulators, including the Fed, to increase the size of the capital cushion they’re required to have to absorb losses. That process is being driven by Vice Chair for Supervision Michael Barr, but the full Fed board has to work through it.
“I will make sure there’s enough time for governors to review the final proposal,” Powell said. “We’ve been briefed on the contents of it, and it’s still in motion,” adding: “It’s possible there would be further changes before the vote or as a result of the vote.”
During Powell's testimony this week — he also testified before the House Financial Services Committee on Wednesday — Republicans repeatedly expressed concerns about the effect that higher capital requirements could have on the economy.
Less of a stigma for turning to the Fed?
The number of banks borrowing from the Fed, in exchange for pledged collateral, has been elevated since the collapse of Silicon Valley Bank and other regional lenders earlier this year. Powell said he’s hopeful that means there’s less of a stigma for using the central bank’s so-called discount window, which is at the heart of why the Fed was created in the first place: to supply cash to the banking system when people get jittery.
To further encourage such lending, the central bank also rolled out a new program that offered collateralized loans for up to a year.
“I actually think it’s good that banks have been willing to use the discount window and the new facility during this crisis,” he said. “It’s almost like the stigma is a little bit less than it was. I want to think that, anyway.”
Sen. Mark Warner (D-Va.) said he would like to see that stigma disappear, citing the rapid deposit run experienced by SVB.
“In an era where people can move capital so quickly, having that liquidity tool available and not taking a huge amount of hits for using it would seem to me to be something that could at least take on this question of these internet-driven runs,” he said.
