Powell faces high-stakes gamble on US economy in final Jackson Hole speech

Colby Smith

 

Jerome H Powell, the chair of the Federal Reserve, is on the cusp of taking a big gamble with the US economy. 

He and his colleagues must soon decide which of two significant risks takes priority now that the Fed’s goals of low, stable inflation and high employment are in tension with each other. Inflation, still too high for the Fed’s liking, is rising again as businesses navigate President Trump’s global tariffs. The labor market also looks increasingly fragile, with monthly jobs growth slowing nearly to a halt this summer. 

If the Fed puts more weight on the threat of resurgent price pressures and holds interest rates steady when it meets next month, that could raise the odds of an economic downturn. If the Fed instead moves to shore up the labor market by restarting interest rate cuts that were put on hold in January, inflation may be more likely to get stuck above the central bank’s 2 percent target. 

 

Powell’s high-stakes balancing act will be on full display on Friday when he makes his final address as Fed chair to the world’s leading economic policymakers at the foothills of the Teton Range in Jackson. His remarks over the past seven years have been the biggest draw of the three-day conference, which is set to kick off on Thursday. Hosted by the Federal Reserve Bank of Kansas City, it has for decades served as the top forum for central bankers, government officials and academics to debate pressing economic issues. 

Since Powell’s most recent public appearance in late July, the prospect of an interest rate reduction in September has risen sharply as fears about the labor market have begun to overshadow lingering concerns over inflation. So has the White House’s pressure on the Fed to substantially lower borrowing costs. On Wednesday, the president expanded his attacks beyond Powell and called on Lisa Cook, a member of the Fed’s Board of Governors, to resign, citing unconfirmed allegations that she may have engaged in mortgage fraud. 

This backdrop leaves Powell, whose term as chair ends in May, with the tall task of laying the groundwork for interest rate cuts without looking as if he is capitulating to Trump or turning prematurely sanguine on inflation. He could do that by suggesting the central bank can afford to reduce the degree of restraint it is imposing on the economy without going so far as to endorse outright easing. 

“They’ve got multiple risks that they have to contend with,” said James Clouse, who served as deputy director of the Fed’s division of monetary affairs until May. “Exactly how they conduct policy in this environment is just very difficult and involves weighing the cost of inflation over the longer run versus the near-term costs of an economy that is weakening.” 

Cutting interest rates when inflation is moving in the wrong direction would not be the first gamble of  Powell’s tenure as Fed chair. One of the most recent — and costly — was in 2021 when the central bank deemed pandemic-era inflation “transitory.” 

That prognosis ended up being very wrong, with inflation soon surging to a four-decade high as red-hot demand collided with constrained supply chains. The Fed raised interest rates sharply and held them at a high level for an extended period to wrestle inflation back down to 2 percent, with appreciable success until  Trump’s tariffs unleashed fresh price pressures. But the institution is still grappling with the fallout of its mistake. 

One of the most tangible consequences is the gutting of a strategy, rolled out in 2020, that amounted to a revolution in the way the Fed set monetary policy when inflation was languishing and interest rates were close to zero.  Powell is expected to elaborate on the proposed changes on Friday. 

In practical terms, the 2020 framework meant the Fed would temporarily tolerate periods of higher inflation to make up for past stretches when it was too low. Officials would no longer raise interest rates just because joblessness was falling, but would wait to see price pressures climbing sustainably before taking action in a bid to maintain as robust a labor market as possible. 

“In hindsight, it was a mistake,” said Raghuram Rajan, a former governor of the Reserve Bank of India. “This was a proactive measure to try and boost the effectiveness of the Fed’s armoury, but unfortunately it came just when the problem changed.”