Adam Posen Thinks Things Could Get Very 'Messy' for the Fed

Adam Posen critiques the recent speech by the Fed chair, rating it a B minus, while noting it created confusion regarding interest rate intentions. He suggests that if the chair's early statements are seen as growing pains, the speech could be upgraded to a B plus in six months. Posen emphasizes the necessity of hiking interest rates and welcomes the Fed's decision to address real inflation, contrasting this year's speech with last year's.

Posen expresses concerns about the chair's discretion in decision-making, which raises issues among former central bank officials. He highlights the reaffirmation of the 2% inflation target but argues that wage inflation is not a reliable predictor of overall inflation. The principles section of the speech raised more questions than it answered, and Posen warns that a lack of clarity on the "right speed" for inflation could lead to confusion similar to past years.

Another speaker notes that Chair Warsh reserves the right to make last-minute decisions without committing to indicators, reflecting a trend of increasing power for the Fed chair since Volcker's era. This discretion is viewed as a worrying trend for future monetary policy. The speaker also points out that inflation has been above target for 64 to 65 months, partially blaming the Fed for being late to hike rates in 2022 and for previous rate cuts.

Posen warns that the Fed's independence is under threat from political pressures and potential changes to its mandate, predicting that the situation could become very 'messy' due to these fiscal pressures. He disagrees with Kevin Warsh's assertion about wanting more dissent within the Fed, suggesting that the perception of dissent may have been influenced by the need for solidarity during COVID and political attacks.

He emphasizes that the Fed's credibility hinges on its ability to maintain independence and resist political manipulation. Posen anticipates that the Communications Committee will produce significant surprises, likely offering more practical recommendations than expected. He mentions Mervyn King's growing skepticism about central bank communications and warns against the moral hazard of central banks providing misleading information to the markets.

Posen discusses the trend of economists moving to AI companies, suggesting it mirrors past tech booms. He acknowledges the transformative potential of AI technology while cautioning that the hype may be overblown and its benefits could take longer to materialize. He emphasizes that the current economic impact of AI is more pronounced in terms of prices and inflation rather than productivity or job creation.

Posen predicts that while job displacement due to AI is likely, it has not yet materialized, cautioning against attributing the current lack of hiring solely to AI, as other factors like post-COVID job reshuffling are also at play. He expresses skepticism about extreme predictions of significant productivity growth from AI, arguing that such claims are overly optimistic and not backed by current evidence.

On inflation, Posen forecasts it will reach 4% by the end of the year and asserts that the US labor market has proven more resilient than the Federal Reserve anticipated. He believes that credit availability and fiscal policy have been looser than expected, leading him to predict that the Fed will raise interest rates in September or December, with Fed funds likely increasing by 75 to 100 basis points in six months.

Posen warns that the next inflation shock could be worse and criticizes the Fed's policy as insufficiently restrictive. He points out persistent inflation in core service measures and notes that AI models currently lack the capability for nuanced human judgment.