Federal Reserve Chairman Jerome Powell testified in front of the Senate Banking Committee this week, and while his comments didn’t stray far from the usual script, markets were spooked by his steadfast commitment to fighting inflation with interest rate hikes.
“The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” he told senators, referencing January’s strong jobs report and signs of resilient consumer spending. The S&P 500 dropped 1.5% after Powell spoke, and has struggled through the week.
The Fed chair’s comments come after a battle with inflation that has lasted more than a year, where Fed officials have raised interest rates eight times in order to cool the economy. So far, their efforts have yielded mixed results. Year-over-year inflation, as measured by the consumer price index, dropped from a 9.1% June peak to 6.4% last month. But Powell said this week that although inflation is fading, the path back to the Fed’s 2% target is “likely to be bumpy.”
That means interest rates will need to be higher for longer, which is bad news for many investors, homebuyers, and businesses. But Wharton professor Jeremy Siegel believes the Fed chair is making a mistake.
“I think the Fed’s policy is very misguided, and let me tell you why,” he told CNBC Thursday. “This month is the third anniversary of the COVID crisis. Over that period, wages have gone up less than inflation. It’s hard to argue that wages are causing inflation when they’ve gone up less than inflation.”
Siegel noted that wages in the U.S. typically rise 1% to 2% more than inflation. “Workers are way behind where they have been historically over the past three years,” he said.
To his point, median weekly real earnings in the U.S., which account for the impact of inflation, declined more than 7% between the second quarter of 2020 and the end of last year. And in January, real average hourly earnings, which also account for inflation, sank 1.8% year over year, according to the Bureau of Labor Statistics.
Still, in his testimony to Congress this week, Powell made it clear that he believes wage growth will need to be slowed to defeat inflation.
“Wages affect prices, and prices affect wages,” he said. “I do think that some softening of labor market conditions will be—will happen as we try to get inflation under control.”
Siegel, on the other hand, argued that wages are rising because of a lack of available workers. In February, there were roughly 10.8 million job openings in the U.S., but only 5.7 million unemployed workers. Siegel believes that Powell is attempting to correct this lack of labor supply through interest rate hikes, but it just won’t work.
“It’s not the job of the Fed to offset a supply-side shift. They control aggregate demand. I think their focus on how tight the labor market is—suddenly, a monomaniacal type of focus—is the wrong way to go about it,” he said.
Siegel argued Powell should forgo raising interest rates in March, particularly by an outsize 50 basis points, and wait for the effects of previous rate hikes to work their way into the economy and slow inflation. He pointed to fading commodity prices, freight shipping rates, and housing market activity as evidence that Powell has already made progress toward his goal of price stability.
Fortune’s CFO Daily newsletter is the must-read analysis every finance professional needs to get ahead. Sign up today.