4 mistakes the Powell Fed made — from a former insider

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Former New York Fed Chairman William Dudley said on Monday that the Federal Reserve made four critical mistakes, driving inflation up and expecting more interest rate hikes to result.

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Fed Chairman Jerome Powell will discuss the Fed’s performance on Tuesday when he testifies to the Senate Banking Committee to consider his nomination for a second four-year term.

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And on Wednesday, the magnitude of the Fed’s challenge to controlling inflation will come into focus as economists expect the government to report that the Consumer Price Inflation Index has risen above the 7% annual rate in December.

The seeds of the Fed’s crisis began in the fall of 2020, when the Fed adopted a new framework to allow inflation to meet its 2% target for a previous period of low inflation.

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Dudley said the first mistake was how the Fed “operated” this framework. The central bank promised that they would not raise the benchmark interest rate to zero until there was 2% inflation for at least a few months and full employment was achieved.

“This means that a starting point for monetary policy liftoff occurs when the economy is already warming,” Dudley said.

Dudley’s comment came in an op-ed on Businesshala news And a subsequent interview. He served as the chairman of the New York Fed from 2009 to 2018.

The Fed’s second mistake was in judging labor market strength incorrectly, Dudley said.

For months, Fed officials underestimated signs of a tight labor market – highlighting instead that labor market participation was lagging.

“I think they were surprised by how quickly the labor market tightened up,” Dudley said.

Dudley said tight labor markets have now translated into wage growth, which is faster than the rate in line with the Fed’s 2% inflation target.

“So even though you think that initial impulse and inflation tends to be transient, you now have a problem because the labor market is tight enough that wages will continue to rise,” he said.

The third mistake the Fed made was viewing inflation as “temporary,” he said.

“I think a lot of the inflationary pressures that we’re seeing are transient but have been going on for a very long time and have a much higher rate than they expected,” he said.

Dudley said the final mistake was that the Fed was too concerned about scaring the bond market and causing another “taper tantrum.”

“I think they were a little too gentle with their communication to the financial markets because they were concerned that the bond would provoke a sell-off in the market. I think the problem right now is that the markets are not taking them seriously,” Dudley said.

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Dudley thinks the Fed will start raising its benchmark rate four or five times this year and will eventually have to raise the benchmark rate to 3%-4%.


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