The Fed is taming inflation, but politicians want to make it harder next time

SAN ANTONIO — Inflation has plummeted, and a coveted "soft landing" appears within our sights. For that we largely have the Federal Reserve to thank. Yet misguided politicians on both left and right are undermining the central bank's ability to achieve this feat ever again.

Standard inflation measures, which soared close to 9 percent in 2022, are today a mere stone's throw from the Fed's 2% target. Meanwhile, unemployment is near historical lows. The recession that many predicted, and feared, hasn't materialized (and is generally no longer expected for 2024, either).

Lefty politicians and their advisers have been taking a victory lap over this record. This is bizarre, given that government officials adopted pretty much none of the tools these heterodox thinkers recommended. That is, rather than introducing kooky, punitive measures targeting "corporate greed" (such as price controls, windfall-profit taxes or stock-buyback bans), the main way the government tackled inflation was through boring, conventional measures that leftists fought against: i.e., the Fed raising interest rates.

Populist politicians admonished the Fed while this was happening. Some, such as Sen. Elizabeth Warren, D-Massachusetts, suggested the central bank was trying to put people out of work. The implication was that a recession was not a possible unintended consequence of rate hikes but, rather, a deliberate "plan" to hurt defenseless workers.

Some in this populist contingent continue to berate the Fed. Rep. Ro Khanna, D-California, for example, recently tweeted that Fed Chair Jerome H. Powell must start cutting interest rates immediately. "If he doesn't," Khanna warned, "he may be the person most responsible for the possible return of [Donald] Trump."

Such explicit linkage of monetary-policy decisions to partisan outcomes is similar to rhetoric deployed by Trump and Trump wannabes. It's dangerous when it comes from the right, and it's dangerous when it comes from the left, too.

Here's why.

There are likely multiple reasons that inflation has slowed in recent months. Some of them — such as global supply chains untangling — likely would have happened on their own. But two factors involve the Fed's ability to remain politically independent and (critically) to be viewed as such.

The first Fed-related factor is obvious: Higher interest rates directly "cooled" demand. They made it more expensive for people to borrow to purchase new things (such as cars and houses).

Rate hikes are usually unpopular, since they're blunt instruments that can cause collateral damage. That's what all those recession warnings referred to. There's a reason the painful, fraught decision to raise rates is left to technocrats shielded from short-term electoral outcomes rather than, say, Congress. It's a tough medicine, and not everyone has the stomach to administer it.

Surprisingly, however, the Fed's medicine this time around seemed to work better than expected — that is, with relatively few side effects.

Why? That brings us to the Fed's second big contribution: "inflation expectations." Even as inflation itself was rising in real time, longer-term expectations about future inflation stayed relatively flat, surveys show. Fed policymakers remained convincingly committed to crushing inflation, even in the face of a potential recession and an active, anti-Fed vilification campaign. And the public believed them, which meant the Fed didn't need to raise rates quite as much as might have otherwise been required.

"A subtle way in which the Fed should get credit for part of what happened is in the 'anchoring' of expectations," Emi Nakamura, a University at California at Berkeley economist, said at the American Economic Association's annual meetings in Texas. She said this "probably made a big difference in the extent to which this episode of disinflation was less painful than previous episodes."

Think of it this way: If people don't believe the Fed is committed to lowering inflation, then businesses negotiating, say, five-year deals might bake faster price increases into their contracts. This is how short-term shocks can cause entrenched inflation. Expectations become self-fulfilling.

This kind of thing has happened repeatedly in countries that lacked politically independent central banks, such as Argentina. It's also why inflation was once difficult for the Fed to stamp out in the United States, too.

Fed officials in the 1970s were less independent and more reluctant to administer painful medicine. Sometimes Fed officials caved under political pressure, as some historians believe happened when President Richard M. Nixon leaned on Fed Chair Arthur Burns to help the president's reelection campaign. Ironically, Khanna tried to insult Powell by comparing him to Arthur Burns, while, ahem, leaning on Powell to help the president's reelection campaign.

In the decades since the Burns era, the Fed has worked hard to rebuild its reputation for independence, and for doing whatever it takes to stamp out inflation. That paid off these past two years. But it's easy to imagine a world with worse economic outcomes — one in which the president installed inept cronies in Fed jobs or Congress arm-twisted the Fed into doing things that seemed more popular.

At least in the short run, anyway.