The Fed Should Think in Terms of a Trilemma

After the Federal Reserve meets Nov. 1 and 2 this week, we may know more about how this Fed will be remembered: as a Volcker Fed that decisively conquered inflation or, instead, a Burns Fed that allowed the country to slip into a stagflationary quagmire. But this already complex reality is even more complicated. Fed Chair Jerome Powell faces a policy challenge that could well prove more challenging that that faced by his predecessors from the 1970s and 1980s: lowering inflation, sidestepping undue damage to the economy and livelihoods, and avoiding a financial accident in the process.

While the market consensus for this week’s Fed policy meeting is heavily in favor of a record fourth consecutive 75-basis-point interest rate hike, views diverge significantly on what the Fed should signal about its future moves. Some think the Fed should suggest a significant slowing of the pace of rate hikes in face of a weakening economy, both domestically and internationally. This, they say, would protect growth and save jobs.

Others, given that core inflation is still going up, think that the Fed should maintain its hawkish tone by signaling the continuation of a robust hiking pace and pointing to a higher peak rate. This, they say, is what’s necessary to defeat inflation and avoid stagflation. Then there are a variety of views somewhere in between.

Contrasting the Fed as led by Arthur Burns with the Fed as led by Paul Volcker has been used as shorthand for this debate between jobs on the one hand and inflation on the other. Derived from the experience of the 1970s, the Burns Fed refers to the notion of a central bank that erroneously moderates its fight against inflation only to be later forced into a U-turn when confronted with a stagflationary mess. The Volcker Fed, derived from the events of the 1980s, refers to a central bank that is willing to tolerate significant damage to growth and jobs in order to sustainably defeat inflation. (My Bloomberg Opinion colleague Bill Dudley described well what is at stake in both cases last week.)