The Fed Has Overtightened

Fed Chairman Jerome Powell recently told the Economic Club of New York that Federal
Reserve policy is currently not too tight (Powell, 2023). I disagree. The Fed makes its
judgment, Powell says, by ‘looking out the window’ (Barrons, 2023). The problem with this
is that Chair Powell may be looking out of the wrong window.

What Chair Powell mentions in making his judgement are:

• Inflation. While core inflation on a three- or six-month annualised basis is below three
  per cent, the Fed is not confident this will last.
• The labour market. While conditions are still tight, the labour market is cooling.
• Growth. Strong third-quarter growth runs counter to the Fed’s desire to see a sustained
  period of below-trend growth and some further cooling in labour market conditions.
• Monetary policy. Policy is restrictive. There has been a rapid tightening in monetary
  conditions and these tightening effects remain to work through fully to the real economy.

It is noticeable that the order in which Powell talks about these indicators takes the most
lagging indicator first, the second most lagging next, and so on. This is precisely the reverse
order in which a forward-looking central bank should be analysing developments. The Fed
is driving the car looking out of the rear window, not out of the front. Moreover, just as
Chair Powell earlier ignored signs of pending inflation, now he has taken his eyes off dials
that together signal that the economy is in a significantly perilous position.