Fed Facing Reassessment of Monetary Policy: Powell's Plan for Crucial Interest Rate Course

Jay Powell, Chair of the Federal Reserve, has announced a potential adjustment to monetary policy. However, there remains uncertainty about the extent and pace of interest rate cuts. A swift and significant reduction in rates, however, seems warranted. Unlike other central banks, the Fed follows a dual mandate: price stability and maximum sustainable employment. With Powell expressing confidence in approaching 2 percent inflation, the focus is now more on the labor market. At the Central Bank Conference in Jackson Hole, Powell emphasized that the Fed would do 'everything to support a strong labor market.' This rhetoric is reminiscent of Mario Draghi's famous statement from 2012, when he committed the ECB to preserving the euro at all costs. The adjustment of monetary policy to support economic expansions is complex. Powell cited the years 1965, 1984, and 1994 as examples of successful 'soft landings.' Alan Blinder classified the year 1999-2000 as a 'soft landing.' Nonetheless, such scenarios remain rare, and alternatives like recessions are common. Previous soft landings were characterized by significant interest rate cuts. In 1984, rates were reduced by more than 3 percentage points within four months, by 2.75 percentage points in the first half of 2001, and gradually by 0.75 points over seven months in 1995. Such measures were always taken before the labor market deteriorated significantly. In previous cases where the Fed achieved a soft landing, the unemployment rate rose only minimally before rate actions were taken. The current labor market, however, shows an unemployment rate that has risen by nearly one percentage point, contradicting previously successful precedents. Signals for a necessary policy shift are also evident in the housing market, a significant transmission channel of monetary policy. According to the US National Association of Realtors, housing affordability has fallen to its lowest level since the mid-1980s. The current high Fed policy rate has reduced core inflation from 5.6 percent to 2.6 percent. However, the current interest rate of 5.25 to 5.50 percent exceeds the estimated neutral rate of 2.5 to 3.5 percent, which hinders the economy. With upcoming presidential elections, there are doubts about a radical change in Fed policy. The question remains: Can the Fed maintain inappropriate policy without jeopardizing its political independence? September offers a final opportunity for course correction before the election. Given the six to twelve-month lag effect in monetary policy, the time for a significant rate realignment has come. The Fed will continue to act data-dependently, but avoiding weak labor market conditions is now of essential importance. Otherwise, the Fed risks its policy being perceived as passive-aggressive.