The US Fed rubs the shine off Davos Opinion by Irwin Stelzer

The Sunday Times has published an article where it says that experts worry that by hiking rates sufficiently to get inflation down to its goal rate of 2 per cent, the Fed would over-egg the anti-inflation pudding and trigger a severe recession. Caliber.Az reprints the article.

Life in Davos at the World Economic Forum last week just wasn’t what it was in the days of zero real interest rates, booming share prices, handsome executive bonuses and a settled world order.

The bosses in attendance, some coming fresh from the financial and property sector firing lines — jobs, not bullets — expect a recession, albeit one that is neither deep nor prolonged. They also fear a “polycrisis” — a mix of woes ranging from Ukraine, to Taiwan, to whatever particular nightmare awaits when corporate head meets pillow.

There can be little doubt that the Federal Reserve is succeeding in slowing the economy. December’s drop in retail sales, the fastest in 2022, made it three of the past four months in which sales fell. Industrial production also declined in December, as did new housing starts (down 22 per cent compared with 2021), building permits (-30 per cent), and auto sales (-7.8 per cent).

It may be that the still well-heeled American consumer is ready for a rest, at least from buying stuff. Which is why chief executives and the Fed’s extensive network of business contacts expect very little growth in the near term.

Meanwhile, increases in prices at both the producer (wholesale) and consumer levels, although high by any standard, are moderating. “Clearly, inflation has peaked. That is no longer a question — it’s a fact,” announced Morgan Stanley chief James Gorman. The consensus guess is that after a 0.25 per cent interest rate rise later this month, and perhaps one more, the Fed will pause to behold the effects on economic activity and prices of taking the benchmark rate from zero to about 5 per cent.

Declining activity is doing little to ease a tight jobs market. Claims for unemployment insurance have fallen for three straight months, and job creation continues apace. As noted in the Fed’s monthly summary: “Firms continued to report difficulty in filling open positions . . . and some employers have continued to offer bonuses and enhanced benefits to attract and retain workers.” Some but not all of this was in response to labour hoarding, holding onto workers even as business slowed.

Many experts fear the Fed will over-egg the anti-inflation pudding, and cause a serious recession by raising rates enough to drive inflation down to its 2 per cent target rate. That target sprang from the fevered brow of a New Zealand finance minister, seemed about right to many central bankers, and became the cornerstone of Fed monetary policy. That Kiwi official’s epiphany occurred more than three decades ago.

Now, some 3.5 million workers have left the US labour force — some to retire, some to enjoy inter-generational wealth transfers from indulgent parents, some to accept benefits from which work requirements have been removed. That might force the Fed to choose between a combination of its target and a slower economy — with, say, 6 per cent unemployment — and a growing one with higher wages and inflation, but lower unemployment.

Which might explain why Gorman expects inflation to stabilise at “around 3, 4 [per cent]”. That, reports Barron’s magazine, would not upset middle-of-the-road economists such as Jason Furman (Harvard by way of Barack Obama’s Council of Economic Advisers) and Olivier Blanchard (formerly IMF).

So far, Fed chairman Jay Powell insists he will not think about changing policy — which means the possibility of a higher inflation target is remote, and will remain so unless holding to 2 per cent provokes a big downturn.

That the Davos meetings may have seen better days is far more likely than a Fed policy move. For one thing, Davos is the centre of the globalisation movement at a time when de-globalisation is the central goal of US policy, and Russia’s assault on Ukraine fractures once-global markets in everything from wheat to oil. For another, participants might be scared off by charges of hypocrisy — partying while the world will be in recession, burnishing green credentials in the face of a failure to meet emission-reduction goals set in Paris in 2016.

That’s especially so after no less than John Kerry, President Biden’s leading warrior in the war to keep things cool on Earth, called them out. The vainglorious former secretary of state declared claims that companies had created sufficient carbon-gulping projects to offset emissions from their operations dubious at best. “A whole bunch of companies” say they are going to get to net-zero “but don’t have a clue how they’re going to get there . . . and most of them are not on track to get there”. It will take lots of money, and corporate bosses are not ready to sacrifice profits to lop a few degrees off the planet’s thermometer.

Perhaps comforted by the sense that they have had deep thoughts, what Oxfam International’s WEF bulletin called “the top 1 per cent, [who] have managed to seize nearly two-thirds of the $42 trillion in newly created wealth”, ambled onto their jets, added up their carbon credits to make certain their private jets are “net zero” in effect, and headed home — a few to work on a new list of cost-saving redundancies.