Blog 3

Some market forces are working against the Fed’s efforts

This week, the Fed’s Jackson Hole summit has investors bracing for aggressive policy tightening while policymakers anticipate the long-lasting impact of higher interest rates.

To mitigate the impact of declining global trade and persistent labor, energy, and commodities shortages, central bankers might raise interest rates for longer than in past decades. Ex-colleagues believe Jerome Powell will err on the side of hiking rates too much rather than too little. This could push more people out of the labor force, slow economic growth, and contribute to more frequent recessions.

The ensuing reality reflects a possible slowdown or, worse, reversal of the three forces which have kept inflation at bay in recent decades by limiting wage and price increases. Among these three forces are globalization, a glut of cheap labor, and a lack of significant investments by energy and commodity firms.

Before the formation of these three elements, the Fed could enact policies that kept both inflation and unemployment down — a phenomenon later termed the “divine coincidence.”

During the pandemic, economists observed events that constrained the economy’s ability to deliver an ample supply of goods and services. These “supply shocks” hindered growth and fueled inflation. These shocks made it more difficult for the Fed to strike a balance between growth and inflation since tackling inflation ultimately involves suppressing growth and employment.

In such a climate, “there is no divine coincidence anymore,” according to Jean Boivin, Head of the BlackRock Investment Institute.

Fed officials are increasingly concerned that even if prices rise briefly, higher inflation might persist as workers seek higher pay, which companies would pass on to consumers through higher pricing. More frequent recessions could spur and destabilize popular investment strategies by causing more frequent losses in the two primary components of traditional asset portfolios—stocks and long-term US Treasury bonds.