Is Jay Powell lucky or good?

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US inflation is close to target, the unemployment rate is 4.3% and the economy is growing above trend. Bad news can always come — the August employment report is on Friday — but it looks like Jay Powell’s Federal Reserve has managed the economy as well as we can imagine.

After 20 years of thinking about the markets, however, I see the influence of luck everywhere. It’s fair to wonder if Powell, rather than being a historically brilliant Fed chair, was just lucky to be in charge when good things happened. Last week, my colleague Martin Sandbu articulated this possibility very well.

In his Jackson Hole speech, Powell attributed post-pandemic inflation to both supply and demand distortions, and put the subsequent disinflation down to the dissipation of those shocks, the moderation of demand for monetary policy, and well-anchored inflationary expectations. Anchored expectations were particularly important, he said, and the Fed’s vigilance in both current and past cycles contributed to this.

Sandbu’s point is that if Powell dropped monetary policy from his disinflation explanation, the explanation would still work. Has monetary policy cooled the labor market by reducing aggregate demand? Well, demand hasn’t weakened much, and the cooler labor market could only be explained by the end of pandemic disruptions. Has the sharp rise in interest rates kept inflationary expectations anchored by moderating the behavior of people who negotiate wages and set prices? Well, market measures of expectations stabilized in the spring of 2021 before rate policy tightened.

I posed this basic challenge – was Powell lucky or good? — to four economists and received an interesting range of responses. Paul Ashworth of Capital Economics believes that policy made a cold demand, but circumstances, particularly immigration, were more important:

I believe that the fall in inflation was due to a reduction in supply shortages, particularly the immigration-led return to labor supply, rather than a weakening of demand attributable to tighter monetary policy. But that doesn’t necessarily make Powell “lucky.” . . weaker demand played a role for which the Fed could take credit.

Powell also pushes the line in his Jackson Hole speech that the Fed’s “prompt” hikes were also important because they kept inflation expectations firmly anchored. I’m less convinced about that supposed channel.

Harvard’s Jason Furman is less skeptical of the anchoring effect and notes that demand has cooled in key sectors:

The soft landing would never have happened without the extraordinary tightening of monetary policy. Most importantly, the Fed has kept inflation expectations anchored, showing it is willing to act as aggressively as necessary. In addition, the Fed reduced demand in certain sectors, particularly construction, which ensured that as fiscal stimulus and supply shocks faded, there would not be another round of inflationary pressures.

Strategas’ Don Rissmiller also points to the possibility of a resurgence of inflation:

We are not quite at 2% inflation. Maybe we’re close enough (I’d say we are), but there’s been a lot of research about how the first part of the adjustment is easy and the “last mile” is hard. So one of the reasons (the economy) looks good is that we haven’t actually finished the race. . .

In the 1970s (inflation declined as the shocks subsided). Inflation has dropped three times. . . the problem is that it just came back three times (and sped up).

Rissmiller believes some credit for the lack of a rebound goes to the Fed, for keeping expectations anchored with aggressive rate hikes. But he believes there was also some luck involved in the soft landing. Immigration has helped cool the labor market in the first place. On the other hand, the Fed was able to slow and then stop raising rates, in part because there was a mini-financial crisis that was bad enough to scare everyone, but not bad enough to trigger a recession: the failure of Silicon Valley Bank. “It’s more like luck than a plan,” says Rissmiller.

Adam Posen, president of the Peterson Institute, believes that if the Fed had not raised interest rates, expectations would likely have been unanchored and inflation would have taken longer to fall. The long period of low inflation that preceded the pandemic also helped anchor expectations, as did parallel actions by central banks globally. The surprising good fortune was how little damage those rate hikes did to the economy:

This was partly because the financial system and the balance sheets of households and businesses were so strong in 2019 and for the most part improved during Covid, which no one predicted.

This was partly because the neutral real interest rate rose for a number of reasons during Covid, which I expect to persist. Therefore, the given policy was not as tight as the Fed and others thought, as seen in the loose credit conditions.

So the Fed certainly didn’t cause the soft landing. Remember, President Powell’s 2022 Jackson Hole speech was about being ready to inflict pain, and everyone expected the pain to come (including me).

Posen, like others, believes that the added labor supply from immigration has helped, but adds another positive supply shock due to higher productivity:

What caused the soft landing were two unanticipated positive supply shocks from early 2022: a large increase in immigration, expanding the labor force and reducing labor costs; an increase in productivity growth above the pre-Covid trend.

No one saw any of this coming, and the Fed had no influence on any of it. I would argue that the increase in productivity was due to the reallocation of American workers to better/bigger/more productive employers following mass unemployment due to the Covid epidemic in the first half of 2020.

In general, the soft landing would not have been possible without a lot of luck. Pandemic disruptions have faded. An increase in immigration has helped weaken the labor market. An unexpected increase in productivity also helped. The SVB mini-crisis caused a slowdown in rate hikes at what turned out to be just the right time. And a higher neutral rate meant that rates were never as tight as they seemed, meaning less economic damage for the same signal of serious intent from the Fed. And in the background, a long period of disinflation and central bank vigilance before Covid made it more likely that inflationary expectations would not be unleashed.

That said, Sandbu’s point that expectations were stable even before policy began to tighten is well-taken, but not a device. By the time the Fed started raising rates, many observers were screaming that the central bank was “behind the curve.” Aggressive action then allayed fears; so credit goes to the Fed there. Sandbu is right that we can’t be sure about that, but the basic picture makes sense.

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