Despite recent inflation nearing double digits, market expectations for inflation five years out remained stable at the Fed's 2% target. Austan Goolsbee argues this was only possible due to the Fed's credibility, which prevented a dangerous spiral where people's actions make high inflation a self-fulfilling prophecy.

By choosing inaction over rate hikes or hawkish communication, the Fed is betting that inflation will moderate on its own in the near future. If this gamble fails and inflation remains high, the Fed will face a significant credibility challenge and be forced to take more aggressive action later.

In a crisis, the public knows no one has all the answers. Attempting to project absolute certainty backfires. A more effective strategy is "confident humility": transparently sharing information gaps and explaining that plans will evolve as new data emerges, which builds credibility.

The market's negative reaction to Fed Chair Warsh's first meeting—weaker stocks and a stronger dollar—is not a failure. It's a crucial first step to establish credibility. By demonstrating a willingness to tolerate short-term market pain, the Fed proves its commitment to its inflation mandate over placating investors.

According to Fed President Austin Goolsbee, Jerome Powell's legacy is defined by preventing potential disasters many experts deemed inevitable: the COVID collapse becoming a financial crisis, the SVB failure causing a credit crunch, and the 2023 inflation drop occurring without a recession. This reframes leadership evaluation based on averted crises.

The Federal Reserve can tolerate inflation running above its 2% target as long as long-term inflation expectations remain anchored. This is the critical variable that gives them policy flexibility. The market's belief in the Fed's long-term credibility is what matters most.

Central bank credibility is a finite resource. By not fully stamping out inflation to its 2% target, the Fed depletes its credibility, making the next inflationary shock harder and more costly to control—a lesson from the recurring inflation of the 1980s.

Even as recent inflation surged, market expectations for inflation five years out remained stable at the Fed's 2% target. This demonstrates the power of the Fed's credibility. If the market loses faith, it can trigger a self-fulfilling wage-price spiral, making it much more painful for the central bank to rein in inflation.

In any economic crisis, whether deflationary like 2008 or inflationary like today, a policymaker's most crucial asset is their credibility. Fed President Austan Goolsbee shares this lesson from former Fed Chair Paul Volcker, warning against making promises or statements that could be proven wrong, as it makes managing the crisis significantly harder.