Powell Is Fighting for the Minds of the People

Powell Is Fighting for the Minds of the People

If all goes according to Federal Reserve Chair Jerome Powell’s baseline forecast, the current surge in U.S. inflation will prove transitory, despite the central bank’s persistent efforts to stimulate growth and reduce unemployment. But what if people stop believing in this benign outlook? This is one of the greatest risks the Fed now faces.

The Fed’s power to manage the economy rests in large part on public confidence. If households and businesses trust officials’ judgment, they’ll expect consumer-price inflation to stay near the central bank’s 2% target in the long run. As a result, they’ll be less likely to demand and offer wage increases, which will help ensure that any surge in inflation proves temporary.

But what if the Fed’s forecast proves wrong, a possibility Powell has acknowledged? A longer-than-expected bout of higher inflation could raise doubts about the central bank’s commitment to its inflation objective. As a result, people’s expectations of future inflation could rise, leading them to respond in ways that would make actual inflation more persistent.