Chairman Powell, the Fed, may be victims of their own success

I, for one, am very happy with the Federal Reserve Board and its chairman, Jerome Powell, because their monetary policy has been fully successful in increasing employment and keeping inflation low, improving the welfare of the American consumer.  

Actually, Chairman Powell has been more successful in achieving the Fed’s dual mandate of increasing employment, and keeping inflation low than any other Fed chair in recent history: 96 percent of the people in the labor force are working, and most of the remaining 4 percent do not have the skills needed by employers. The average core inflation rate from January-June was 2.0 percent, the desired rate by the Fed. 

This success is due to the Fed’s independent, even-keeled, incremental approach to increasing the discount rate, which I affirmed was necessary to support an expanding economy. By now, this assessment is shared by many economists and financial experts in the U.S. and abroad.

In fact, Powell has been so successful, perhaps too successful, that I am concerned with the new challenges that he is facing, challenges that were partly created by his success. These include:

• a very tight labor market and a hot economy;
• an upward-creeping inflation rate;
• the use of more tariffs in international trade, which could escalate into trade wars; and
• the possibility of increased political interference with the independence of the Fed. 

The Fed is facing a very tight labor market with very little room to increase employment, especially since many of the unemployed cannot supply the skills that employers demand. This alone exerts upward pressure on wages, that is, an upward inflationary squeeze.

In addition, the economy and interest rates have picked up steam in recent months: 2018 GDP has increase from 2.2 percent in the first quarter to 4.1 percent in the second quarter — an 86-percent increase.

Although average core inflation, which excludes volatile food and energy prices, in the first half of the year was at the desired Fed target of 2 percent, this rate has been creeping up from 1.8 percent in January to 2.3 percent in June.

The picture of the general inflation rate, not just core, stood at 2.9 in June 2018. All of this reinforces the inflationary build up in the rapidly growing economy and puts the Fed in the path of additional rate increases to keep the economy and inflation from rising too fast.

Furthermore, it is well established that increasing tariffs, like increasing taxes, on goods and services imported to the U.S. translates into higher prices and lower consumer demand for those goods and services in the U.S. When such U.S. demand goes down, it will likely lower their prices in the markets of the exporting countries.

Likewise, with tariffs imposed by other countries on goods and services imported from the U.S., such tariffs increase prices and lower demand for U.S. products in the importing countries. Lower foreign demand for American products, like soybean and corn, increases their supply and lowers their prices in the U.S.

This lowers the profits of U.S. producers and could lead to net losses — unless the administration comes to the rescue. Cognizant of this, on Tuesday, the administration budgeted $12 billion to assist affected farmers.

Nonetheless, the net effect of such tariffs is inflationary in the U.S. because it imports more than it exports. This inflationary effect is likely to be more severe if the tariffs evolve into trade wars.

Finally, the recent dismay of President Donald Trump with the Fed’s practice and inclination to raise the discount rate in the future could sway the Fed into taking undesirable actions, not fully warranted by purely economic considerations.

These challenges are making the job of the Fed far more complicated than it has been so far this year, namely, how to continue the incremental discount rate raises without dampening the robust labor market and consumer demand.

The silver lining in all of this, if there is one, is that imports from weaker economies can help blunt the inflationary pressures on the labor market and creeping inflation.

Powell and the Board of Governors have been very successful so far this year, a success which might be hard to repeat. Yet, they know what they are doing and have wide-spread public and professional support.

Hopefully, with their in-depth knowledge of relevant economic factors and some luck, they will be able to continue keeping inflation in check and increasing employment or keeping it at the present 96-percent rate, thus assuring continued prosperity in the U.S.  

Let’s all get out of their way and let them do their increasingly complicated job.   

Avarahm Shama is the former dean of the College of Business at the University of Texas, The Pan-American. He is a professor emeritus at the Anderson School of Management at the University of New Mexico and his book about stagflation, “Marketing in a Slow-growth Economy,” was published by Praeger Publishing.