The chairman of the US Federal Reserve has finally completed his shift towards a “relaxed” policy. In a speech in Jackson Hole, Wyoming, the site of the annual meeting of central bankers, Jerome Powell put an end to the cycle of monetary austerity that began in March 2022. “The time has come” to cut the Fed’s key interest rate as early as September, he announced.
In his speech on Friday, Powell explicitly acknowledged what has become known as a “prolonged transition phase” in inflation: The slow reversal of pandemic-related supply and demand distortions, combined with the war-related impact on energy and commodity markets, were primarily responsible for the key consumer price growth indices and overall inflation falling back to 2.9 percent year-on-year.
Raising the federal funds rate – the rate at which banks with interest-bearing reserve accounts at the Fed lend money (their excess reserve balances) to each other overnight and which affects borrowing costs across the U.S. and global economies – from 0.25% to a 23-year high of 5.50% and maintaining that level for over a year contributed to this disinflation by “dampening” aggregate demand, Powell noted. However, the labor market is no longer a “source of elevated inflationary pressures.”
Part of the problem is that the primary transmission mechanism at work in “moderation” is frustratingly indirect: it involves weakening employment and wage growth through tighter financial conditions for businesses, which respond by reducing operating expenses (especially wages), which in turn dampens household spending and thus aggregate demand. This is a painful, grinding process. Powell is fully aware of this. At an earlier Jackson Hole Symposium event, he signaled his willingness to induce a recession and “inflict some pain” on households and businesses.
Ultimately, this will work—just as a baby will stop crying if you shake it long enough. While the rate hikes have not “silenced” the U.S. economy, they are clearly an unnecessarily cumbersome and destructive way to combat inflation that Powell himself acknowledges is temporary. This is perhaps counterintuitive, as job growth has been very robust despite the tightening, thanks in part to both Joe Biden’s stimulus package (the American Rescue Plan Act) and the Inflation Reduction Act (IRA). Even taking into account the recent downward revisions, 174,000 jobs were created per month between March 2023 and 2024.
The surge in renewable energy investment triggered by the IRA alone is expected to be responsible for the creation of over 334,000 clean energy jobs since August 2022. However, there is reason to believe that Powell’s approach has done some damage to this process. This is because green investments are particularly “interest rate sensitive.” As with any other manufacturing project, capital is as important a factor as labor and supplies. But green energy projects are more capital intensive because they tend to trade lower operating costs (the inputs to wind farms and solar are “free”) for higher (relatively speaking) upfront costs.
By one estimate, 70 percent of the cost of an offshore wind farm is capital costs, compared to 20 percent for a gas turbine power plant. This means that the vast majority of IRA-related projects require large upfront debt-financed expenditure. As the cost of the debt rises with rising interest rates, so does the levelized cost of electricity (LCOE), a measure of the average cost of generating a unit of energy (kilowatt or megawatt hour) over the life of the plant. And this is even more true for renewables, whose rapid adoption depends on them being cheap and profitable for investors.
As a result, much of the urgently needed expansion of renewable energy capacity and storage – which is extremely time-sensitive given the escalating impacts of the climate crisis – will be postponed until borrowing costs settle to the point where new projects become profitable. Moreover, when interest rates are high, the larger and better capitalized companies can gain a higher market share. Their thicker balance sheets also make it easier to accept higher borrowing costs now in the hope of being able to refinance those loans at lower rates later. The concentration of market power in the renewable energy sector would have all the usual effects on consumer welfare and on innovation, the latter seen as key to the energy transition.
At the national level, it is therefore important to assess the impact of the Fed’s monetary austerity measures by taking into account where income, employment and investment growth, as well as the growth of renewable energy and storage capacity, are. could were. The question is: What would have been different if the high-pressure economy had been allowed to continue for longer and the negative effects of higher prices on real incomes had been countered by other means?
Equally worrying is the global impact of the Fed’s delayed policy change. Powell’s decision comes in the wake of severe shocks to financial markets due to weaker-than-expected economic data in the US and the unwinding of the so-called yen carry trade. This global sell-off was in turn due to differing interest rate decisions by the Bank of Japan (BOJ) and the Fed, with the Bank of Japan surprisingly deciding to raise its own interest rates to stave off pressure on the yen.
Perhaps tellingly, the blame game that followed revolved largely around whether the Fed or its counterpart in Tokyo had made a “policy mistake”: Powell by “falling behind the curve” or Kazuo Ueda by allowing the all-important yen/dollar exchange rate to deteriorate to the point where an adjustment was inevitable. The exchange rate had risen above the psychologically important 150 level due to the BOJ’s adherence to ultra-loose monetary policy despite rising domestic inflation (which put downward pressure on the yen), combined with the Fed’s aggressive tightening of monetary policy (which further encouraged dollar appreciation), making imported goods more expensive for an import-dependent country.
What is obscured in this discussion, however, is the fact that there are very few countries like Japan. Most countries lack the ability to conduct (relatively) independent monetary policy. The vast majority of countries do not have a reserve currency in which liquid financial assets are denominated and which can therefore be used to store the proceeds of trade and financial transactions. The economic fate and short-term financial, political and social stability of these countries inevitably depend on macroeconomic trends and thus on the monetary policy of the United States – with disastrous consequences.
The strengthening of the dollar and global interest rates (other central banks must not only respond to their own inflationary pressures but also follow Fed policy and maintain their respective dollar rates) has led to rising debt servicing and import costs, as well as financial and political instability in developing countries that are already vulnerable to conflict and climate change. Several countries have fallen into currency and debt crises and remain in turmoil.
All this could be described as the latest manifestation of what is known as central banking: once dreary bureaucratic functionaries who ran check-cashing offices for the treasury in the pre-neoliberal era, central bankers like Powell or Ueda are now the shining agents of world history, whose every word carries global systemic and political significance and whose carefully planned press conferences are like a murky nightmare in the minds of financial analysts. At the top of the global monetary hierarchy, Powell (a lawyer turned asset manager) is the epitome of the process that Fernando Pessoa called the “Caesarization of the accountant.”
By responding to price increases caused largely by supply shocks with reckless monetary austerity, the United States has once again shirked its hegemonic duty in global finance – as it did during the Volcker shock and, even more devastatingly, during the interwar period. Today, this failure is exacerbated by the severity of the climate crisis and the need for decarbonization. Developing countries are also in a more vulnerable position than in the 1980s, with their aggregate debt levels far higher and vulnerability to climate change further undermining their financial prospects.
Above all, all this reveals the lack of responsible leadership at the top of the global financial (non)system. It raises again the question of monetary cooperation similar to the Plaza Accord of 1985, in which the United States and other major economies agreed to balance trade and financial imbalances and allow the dollar to depreciate. But the possibility of a new agreement is slim. Without it – and without comprehensive reform of global trade and financial institutions – billions of people around the world, especially in developing countries, will suffer the consequences of monetary austerity and the stalled green transition.
