CONFIDENCE MAN — The Federal Reserve remains perhaps the last widely respected institution in Washington, known for its super wonky, nonpartisan dedication to managing inflation and promoting full employment. It's not a political lightning rod like the Supreme Court. And everyone knows how little people care for Congress or President Joe Biden at the moment. Most people don't know exactly what the Fed is or what it does. But the bank's street cred for green eyeshade professionalism remains. Past chairs like Ben Bernanke, Janet Yellen, Alan Greenspan and famed inflation-buster Paul Volcker remain (mostly) revered figures in the economics world. That golden reputation is now very much on the line. Current chair Jerome Powell and his colleagues at the central bank obviously got it terribly, horribly wrong when they said the current run of historic inflation that began in late 2020 as Covid eased would be "transitory" and level off well before now. Obviously, that did not happen. Inflation popped to 8.6 percent in May, the highest level in 40 years, driven by soaring gas, food and housing costs. Perhaps even more important, consumer and business expectations for future inflation are starting to rise quite a bit. Central bankers obsess over expectations because they drive business and consumer behavior. If the Fed loses the confidence of businesses and consumers in its ability to control inflation, people will pull back on spending and investment in the near term, helping push the economy toward recession. That's why Powell stressed "public confidence" in the Fed's abilities during his press conference today following a big rate hike of 0.75 percent intended to slow down the economy and tamp down rampant price hikes. He mentioned the rise in inflation expectations multiple times as a reason for the larger-than-initially-forecast hike this month, along with inflation readings and signs that consumers, who drive around 70 percent of the economy, are finally starting to feel the pinch and pull back on buying stuff. "There's always a risk of going too far or going not far enough," Powell said in response to a question from my colleague Victoria Guida. He added: "We think that the public generally sees us as very likely to be successful in getting inflation down to 2 percent. And that's critical. It's absolutely key to the whole thing that we sustain that confidence." The hike came after Powell said at the last meeting that he wasn't thinking about 75-basis-point hikes, leading to questions about whether the central bank's guidance is of much use to Wall Street and the general public anymore. Once that confidence in guidance is gone, the Fed loses one of its most powerful tools to influence economic behavior without resorting to draconian hikes almost guaranteed to bring recession and drive up unemployment. A defensive Powell insisted that the bank simply shifted its stance based on the persistence of inflation, drops in consumer confidence and the like. But the hike came after a rapid campaign by the central bank (over like two days) to turn 75 basis points into the new expectations. So markets kind of celebrated that the Fed was very much on the inflation case and might still somehow execute the magical "soft landing" in which inflation falls but unemployment doesn't rise much and severe recession is avoided. Not a lot of economists and market watchers share that confidence. And many fault the Fed for not moving much sooner and faster to tighten its policy on rates and giant infusions of cash into the economy. Today's hike got the Fed's target only to 1.6 percent, still quite low, meaning quite a bit of work remains to be done. The Fed gently began to try to "normalize" monetary policy before Covid hit. At that point it had no choice but to flood the zone with cheap money to avoid a depression. But as Covid's impact waned, the Fed had an opportunity in January of this year to restart its rate hiking campaign and more quickly draw down the gobs of government bonds and other securities it buys to essentially create money. Powell and his colleagues passed. And inflation continued to spike. Then Ukraine and the China lockdowns happened and drove it even higher. Now the Fed is finally waking up to the threat, but it could be too late. Forecasts, according to many economists, show we might ALREADY be in recession with a second quarter GDP report now expected to follow the first and come in flat or negative. "The Fed's acknowledgement that some rise in unemployment will be needed to get inflation down is a step toward reality," Peterson Institute for International Economics senior fellow Joseph Gagnon said in a note today. "But it is likely that either unemployment will have to rise above 4.1 percent or it will take longer than two years to return inflation to target." And Powell's ultimate bottom line was that taming prices is his absolute priority, suggesting he's willing to risk recession to do it. "The worst mistake we could make would be to fail. It's not an option," he said. "We have to restore price stability. We really do. It's the bedrock of the economy." Welcome to POLITICO Nightly. Reach out with news, tips and ideas at nightly@politico.com. Or contact tonight's author at bwhite@politico.com or on Twitter at @morningmoneyben.
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