Powell admits high interest rate could be harmful

United States’ Federal Reserve Chair Jerome Powell told the Senate Banking Committee on Tuesday that the inflation is no longer the sole issue of concern for the central bank and that there is the danger arising from the consistently high interest rate, and that high interest rates over a long period of time could undermine robust economic activity.

This is the first time that the apparently obstinate central banker has stuck to his guns and said that the interest rates – which have remained at 5.25 per cent – 5.5 per cent since last July – will have to remain where they are until inflation is brought down to the mandated 2 per cent; he is now accepting that there is good news, that employment figures are positive and so is the performance of the economy.

He has not however said that this would open up the possibility of cutting the interest rate. He said in response to questions from the senators that he would not send out signals of any kind. Powell said, “After a lack of progress toward 2 per cent inflation objective in the early part of this year, the most recent monthly readings have shown modest further progress. “

Ever since the end of the Covid pandemic in 2022, the American economy had swung through extremes of labour shortage to unemployment, and the irruption of inflation after a steady state financial support for many Americans. It was argued that the inflation was the result of excessive state support for the people. But what seems to have happened is the failure of mid-level banks across the country like the Silicon Valley Bank, which however did not cause the quake in the financial markets in 2007-08, and it is this that had triggered inflation at one level. But whatever be the reason, inflation continued to persist at high levels.

America of course did not face the cost of living crisis as did many European countries and the United Kingdom. Americans lived through the inflation spiral and came out unscathed. But Powell could not take much satisfaction from the fact of the robustness of American citizens’ spending habits. He looked narrowly at the inflation figure and he would not let his guard down as it were. He is now convinced that the creation of new jobs and the falling figures for unemployment give hope that the economy is on a good track and inflation can be tamed over the next months.

American markets have been more nervous about the high interest rate more than the high inflation rate, and they felt that the Fed Reserve should cut the interest to give boost to the economy. The Fed Reserve chairperson was not willing to take the risk which seemed so natural to the market-players. So he held on to the interest rate as he saw fit.

Of course, it was not Powell alone who was holding to the orthodox view that inflation is a greater danger to the economy than anything else. On Tuesday, he did not show any sign of letting the tight grip over interest rate loosen. But his admission that higher interest rate over a long period could undermine growth is seen as a ray of light and glimmer of hope.

American economy remains a paradox because what breaks the back of any other national economy leaves barely a wrinkle in the world’s largest economy. It could be the case that the size of its economy saves America the blushes which befall middle-sized national economies like the European countries. It appears that the American can spend his way out of a depression as through an inflationary phase. It is for this reason America needs a tight-fisted central banker like Powell.