With inflation at its highest level in three decades, the Federal Reserve is expected to start this week reducing the extraordinary stimulus it has given to the economy since the pandemic recession hit early last year, a a process that could prove to be a risky balancing act.
President Jerome Powell has signaled that the Fed will announce after its policy meeting on Wednesday that it will start cutting its $ 120 billion in monthly bond purchases as early as this month. These purchases aim to keep long-term loan rates low to encourage borrowing and spending.
Once the Fed ends its bond purchases by mid-2022, then it will turn to a more difficult decision: when to raise its short-term benchmark rate to zero, where it has been since. that COVID-19 hammered the economy in March 2020. Raising this rate, which affects many consumer and business loans, would aim to ensure that inflation does not run out of control. But that would carry the risk of discouraging spending and undermining the labor market and the economy before they regain full health.
âWe don’t have a roadmap for what we’re going through,â said Diane Swonk, chief economist at Grant Thornton. Powell must “walk a tightrope” in supporting the recovery without “turning a deaf ear to inflation”.
In this uncertain backdrop, President Joe Biden has yet to announce whether he will reappoint Powell for another four-year term as Fed chairman. Powell’s current term expires in early February, but previous presidents have typically announced such decisions in late summer or early fall.
Biden is expected to offer Powell a second term despite complaints from progressive groups that the president has increased risks to the financial system by easing banking regulations and is not sufficiently committed to considering the economic threats of climate change in the Fed monitoring of businesses. Powell is admired on Wall Street and in most economic circles and has been praised for guiding the economy through the recession, in part thanks to an array of emergency loan programs from the Fed.
The Fed’s likely decision this week to cut bond purchases comes as high inflation disrupts the U.S. economy for much longer than Powell and many other officials initially anticipated. Consumer demand for healthy spending has been met with clogged ports, closed factories and labor shortages that have driven up prices for automobiles, furniture, food, building materials. and household products.
On Friday, the government said prices jumped 4.4% in September from the previous year – the fastest 12-month increase since 1991. There was, however, a sign that inflation could fall: excluding the volatile food and energy categories, prices rose only 0.2% from August to September. This was down a tenth from the previous month’s increase and well below the 0.6% jump in May.
Yet wages and salaries rose the most during the July-September period in at least 20 years, according to a separate report on Friday. This suggests that workers are increasingly able to demand higher wages from companies that are desperate to fill an almost record number of open jobs. Large wage increases can drive inflation up if companies raise prices to cover higher costs.
As inflation escalates, the labor market has not returned to full force. The unemployment rate was 4.8% in September, above its pre-pandemic level of 3.5%. And about 5 million fewer people have jobs now than before the pandemic. Many Americans have not yet stepped off the sidelines to look for work, some of them because they still fear the virus or cannot find or afford child care, others because they have decided to take early retirement.
Powell has said he would like the labor market to show further improvement before the Fed starts raising its short-term key rate. Economists expect him to use the press conference following the Fed’s meeting on Wednesday to point out, as he has done before, that the start of the Fed’s reduction in bond purchases will not begin. does not mean that a rate hike is near.
âI think it’s time to gradually cut back, and I don’t think it’s time to raise rates,â he said about a week ago.
The minutes from the last Fed meeting indicate that the central bank will likely reduce its monthly purchases of Treasury bonds and mortgages by $ 15 billion per month. By cutting bond purchases so quickly, the Fed would have the possibility of raising rates by the second half of 2022.
That doesn’t mean it will. At its last meeting, about half of the Fed’s policymakers predicted that the first rate hike would take place in late 2022, with the other half projecting 2023 or later. The timing of any rate hike will, however, depend on whether inflation is still high and whether the Fed believes the job market is back to full health.
Earlier in the pandemic, Powell had spoken optimistically to help restore the unemployment rate to its pre-COVID level, when it hit a low of 3.5% in 50 years. More recently, however, he and other officials have expressed doubts about the ability of the labor market to fully recover.
It is far from clear if or when the several million Americans who have left the workforce will return. Among the newly unemployed are those who live or work in places, such as inner cities of large urban centers, where jobs may never fully return. If many people have indeed given up on the job market for good, the Fed might decide it can assess sooner than it otherwise would.
“They must now think that the workforce has changed structurally,” said Steve Friedman, economist at asset manager MacKay Shields and a former senior executive at the New York Fed.
However, the risk is that the Fed will end up raising rates too soon. Supply bottlenecks could ease in the coming months. If the Fed were to raise rates at the same time, it could depress spending and weaken the economy just as its supply problems recede.
âWe could easily see that demand is slowing just as supply is increasing,â said Randal Quarles, a member of the Fed’s Board of Governors, in a recent speech. âIn the worst-case scenario, we could reduce the incentives to return to supply, leading to a prolonged period of sluggish activity.