Powell faces Senate heat as Fed ramps up inflation fight

Federal Reserve Chairman Jerome Powell took heat from lawmakers Tuesday after warning that interest rates will need to be raised higher as the central bank continues its fight against inflation.

“The ultimate level of interest rates is likely to be higher than previously anticipated,” Powell said during a hearing held by the Senate Banking Committee. 

“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” Powell said.

Higher interest rates are meant to lower prices by slowing economic activity, which can also push the economy into a recession and put people out of work.

There are currently about 5.6 million people looking for jobs, with a national unemployment rate of 3.4 percent, the lowest in more than five decades, according to Labor Department data.

But if the Fed hits its expected year-end unemployment rate of 4.6 percent, there will be more than 7.6 million unemployed people, based on calculations by The Hill. That’s about 2 million more people in need of a job.

“[We’re going to have] 2 million people out of work. Can you stop it at 2 million people?” Sen. Elizabeth Warren (D-Mass.) asked Powell. “History suggests that the Fed has a terrible track record of containing modest increases in the unemployment rate.”

Lawmakers in both parties responded with concern to Powell’s more aggressive stance on future rate hikes.

“When you’re slowing the economy, you’re trying to put people out of work. That’s your job, is it not?” Sen. John Kennedy (R-La.) said to Powell during the hearing.

“You’re trying to raise the unemployment rate,” he continued.

The Fed’s baseline interest rate is 4.57 percent after the central bank boosted the overnight bank borrowing rate to a span of 4.5 to 4.75 percent. Fed officials had expected to boost that rate to 5.1 percent by the end of this year, according to a projection released in December.

But that terminal rate is now expected to be higher and will be updated at the Fed’s rate-setting Federal Open Market Committee (FOMC) meeting later this month.

Warren expressed fears the faster rate hikes would push the economy toward a tipping point.

“Once the economy starts shedding jobs, it’s kind of like a runaway train. It is really hard to stop,” Warren said.

“In fact, 11 out of the 12 times that the unemployment rate increased by a full percentage point within one year, unemployment went on to rise another full percentage point on top of that.”

Powell countered that the Fed could not afford to let up its fight against inflation, which he said would bring much deeper pain if left alone. The Fed chief and his colleagues have repeatedly argued that a recession caused by fighting inflation now would pale in comparison to one caused by hyperinflation in the future.

“Will working people be better off if we just walk away from our jobs and inflation remains at 5 [or] 6 percent?,” Powell said.

Powell also argued that the labor market was too strong to allow inflation to come down on its own, with wages still rising 4.4 percent over the past 12 months, according to Labor Department data.

But there’s growing concern among some economists that due to the specific nature of the inflation seen in the aftermath of the coronavirus pandemic, during which the global economy was shut down and then rebooted, interest rate hikes may not be the best tool for containing inflation.

That’s because rising prices are generally associated with higher labor costs. But labor share of value in the economy has been falling since the pandemic, while the capital share has been increasing along with record corporate profits. 

That’s a deep structural change in the way the U.S. economy functions that has been throwing economists for a loop.

“The fact that the labor share is falling is really clear evidence that this is not an inflation driven primarily by rising wages. It’s just very hard to square those things,” J.W. Mason, an economist at John Jay College in New York, said during an online event on Monday. 

“There’s a number of alternative stories we could tell,” Mason added. ”And I think you can say, well, supply constraints and a rise in global energy prices might actually show up in the U.S. as a rise in profit margins. But I think it’s very hard to square the behavior of labor shares and capital shares with a story of where this is primarily inflation coming from the labor market.”

Lawmakers on Tuesday were also paying attention to these new dynamics.

“Would you agree that changes in the size of corporate profits can be one of the factors that affects the inflation rate?” Sen. Chris Van Hollen (D-Md.) asked Powell on Tuesday, which prompted an affirmative response from Powell.

Van Hollen challenged Powell to contemplate a scenario in which wages and benefits for workers could continue to grow at a healthy level even as inflation comes down to 2 percent, provided that profits for corporations would shrink. Powell said he thought something like this could happen over the “shorter term.”

Markets had been expecting rate hikes of 0.25 percentage points out of the March and May FOMC meetings, but Powell’s comments on Wednesday pushed the probability of a 50-basis point hike at the next meeting above 50 percent, according to a prediction algorithm by financial data company CME.

Powell’s renewed hawkishness on interest rate levels comes after an uptick in the personal consumption expenditures (PCE) price index and a smaller-than-expected drop in last month’s consumer price index (CPI). 

The PCE annual inflation rate rose to 5.4 percent annually in January after declining for several months in a row, while CPI dropped to 6.4 percent annually after analysts thought it would slide further to 6.2 percent.

Inflation is still proving to be a major issue affecting the global economy.

In the U.K., consumer prices were up 8.8 percent annually in January. In Japan, they reached a 40-year high of 4.3 percent in January. In Germany, they were up 8.65 percent and over the course of 2022 German inflation averaged 7.9 percent — its highest level since World War II.