News Article

Giuliana Unger

February 5, 2023

Mr. Powell, Drop The Sledgehammer And Start Innovating

Previously published on Forbes.com

The US Federal Reserve System is living in the past and undoing the future. Chairman Jerome Powell and his colleagues have wielded interest rates like a sledgehammer, hoping to crush inflation the way Paul Volcker did in the 1980s. At this point, however, each additional swing of the sledgehammer hurts our chances of a “soft landing” in 2023 and a habitable planet in 2100.

The sledgehammer cannot distinguish between companies that are building a clean, sustainable economy and those that keep us hyper-distracted by devices, hyper-addicted to fossil fuels and hyper-apathetic to inequality. It cannot distinguish between the haves who can weather a recession and the have-nots who will suffer most.

Moreover, the Fed’s 2% inflation target is arbitrary. It was invented offhand in 1989 by Don Bash, Governor of the Reserve Bank of New Zealand, in response to a law mandating that the country’s central bank have a target. It’s unclear that 2% is any better for society than 3.5%, where we seem to be going.

Worldwide, we need affordable capital to develop technologies that address our climate crisis. We need it to meet the demand for housing, food and water as the world population grows from 8 billion today to 9.7 billion by 2050. And we need it to revive the middle class and create the jobs of the future. That is why I’m calling on the Fed and all other central banks to drop Paul Volcker’s sledgehammer and explore innovative alternatives. How might they blend monetary policy and industrial policy to tame inflation without starving global innovation?

The stakes of reinventing central banking are high. To reach net-zero by 2050, BloombergNEF estimates that we need to invest almost $200 trillion in clean technologies, or about $7 trillion annually, up from $2 trillion in 2021. The point, lest we forget, is to prevent climate change from ravaging economies, destroying human-sustaining ecosystems and destabilizing societies with a mass refugee crisis.

Rate hikes have already slowed venture-backed cleantech development. Climate Tech VC reports that in 2022, venture funding for climate tech fell 3% from its peak in 2021, driven by a 24% drop in growth-stage funding. If we give growth-stage companies just enough funding to fail, they will not outcompete or transform the industrial juggernauts responsible for most emissions.

Interest rate hikes threaten not just the companies of the future but also their employees. Until the 1980s, income levels in the Western world enabled a one-income family to live reasonably well. Now, even two-income families are struggling. Why? Their incomes are too low to make ends meet, while corporate profit margins are the highest they’ve been in the last 400 years as David Dodge, former Governor of the Bank of Canada, illustrated during a recent speech in Vancouver.

If companies prioritize shareholder returns over wages, talent retention and development, the only way for households to increase their income is to job hop. Indeed, almost half of US workers plan to quit their jobs in the first two quarters of 2023 according to a survey by staffing firm Robert Half. And why not: unemployment is at 3.4% and there are 11 million available jobs in the US with two openings for each job seeker.

Such active job hopping will be a major source of wage inflation. Hence, in today’s stretched labor markets, interest rates hikes could result in the opposite of what central banks want. To make matters worse, a labor market defined by high churn will struggle to innovate. Employees will depart before they can create or do anything significant, denying employers the full value of their development investments.

If cleantech remains underfunded and workers must choose between subsistence wages and constant job hopping, net-zero emissions by 2050 will be unattainable. To fund clean innovation while reversing social and economic stagnation in the middle class, we need to address inflation without Paul Volcker’s sledgehammer. We need policies that avoid accelerating inflation while also avoiding the consequences of inflation. I propose three to start:

  1. Align monetary policy with industrial policy. Bills like the Inflation Reduction Act try to compensate for the sledgehammer of interest rate hikes but fall short. Why shouldn’t the Fed set lower interest rates for critical industries like cleantech and chip manufacturing while setting higher rates for fossil fuels and social media?
  2. Pay higher wages and increase productivity. Rather than force people into job hopping in an already tight labor market, which will accelerate wage inflation, we need to develop a structured solution to low productivity and wage stagnation. For example, set higher minimum wages and fund reskilling and apprenticeship programs that enable people to become more valuable in the talent market. Incentivize companies to increase capital expenditures on advanced machinery and industrial processes that can provide real productivity gains. Meanwhile, place higher taxes on share buybacks and excessive dividends.
  3. Put a war windfall tax on hydrocarbons. War in Ukraine has delivered record profits to fossil fuel companies, most of which continue to drag their heels on an energy transition. Tax their war windfall heavily to subsidize and accelerate the roll out of clean energy, which isn’t vulnerable to Vladimir Putin’s megalomania. Although possibly painful in the short-term, this transition will lower the costs of food, energy and housing, the most important markers of inflation. Taxpayers have subsidized oil and gas companies for long enough.

The Fed’s fixation on an arbitrary inflation target of 2% threatens humanity’s future. While I believe central banks need independence to function optimally, there’s no reason they shouldn’t stop further interest hikes now. Inflation is already falling and expected to reach 3.5% with the measures applied so far. That means the dangers of hyperinflation and recession are subsiding. Perhaps 3.5% is the new equilibrium that could aid the world in addressing climate change and sustaining a population of 9.7 billion.

Mr. Powell, it’s time to lay down Volcker’s sledgehammer and innovate monetary policies.

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