Federal Reserve Chair Jerome Powell surely expected to have some breathing room after taking the first step this month to dial back the Fed’s emergency aid for the economy.
Just a week later, though, the government reported that consumer prices grew over the previous 12 months by the most in three decades. The inflation spike has squeezed consumers, posed a threat to the Biden administration and intensified pressure on Powell to act.
Some economists — and some Fed officials — want the Fed to move faster to rein in its ultra-low-rate policies. Other policymakers favor a more patient approach to interest rates. The result is a split within the Fed that Powell will likely have to settle, with potentially far-reaching consequences for the economy.
It all comes just as President Joe Biden is about to announce whether he will offer Powell a second four-year term as Fed chair or instead nominate Lael Brainard, the leading alternative, who is a member of the Fed’s Board of Governors. Powell’s term as chair expires in February.
The question of whether the Fed should act faster to withdraw the enormous aid it injected into the economy to fight the pandemic recession highlights the extraordinarily delicate task before the Fed as it seeks to contain inflation without slowing an economy that is still 4 million jobs short of pre-pandemic levels.
The main source of disagreement at the central bank’s next meeting in December will likely revolve around whether it should accelerate the reduction, or tapering, of its monthly bond purchases. The Fed bought US$120 billion a month in Treasury and mortgage bonds beginning last summer until Powell announced Nov. 3 that the Fed would taper those purchases, which have been intended to lower longer-term rates and encourage more borrowing and spending.
Powell said the purchases will be pared by US$15 billion a month in November and December, which would end them altogether by June. But the Fed did not commit to sticking to that pace; it held out the possibility of accelerating the pullback. Doing so would give the Fed the option to raise its key short-term interest rate as early as the first half of 2022. A rate hike would, in turn, lead to higher consumer borrowing costs for things like mortgages and credit cards.
Jason Furman, a Harvard economist and a former adviser to President Barack Obama, noted in a conversation with reporters this week that the nation’s unemployment rate has fallen faster than expected to a relatively low 4.6%, while consumer inflation has reached the highest level in 31 years, at 6.2%. Higher inflation lowers the effective cost of loans, which makes Fed policy even more supportive of growth — and potentially of inflation — than it was early in the pandemic.
All those factors, Furman suggested, justify a faster tightening of the Fed’s low-interest rate policies. He said the Fed should finish tapering by March, plan to raise rates in the first half of next year and potentially do so three times in 2022, unless inflation were to quickly fall back.
“The problems in our economy,” Furman said, “are not enough shots in arms, not enough throughput in ports. Buying assets and keeping interest rates low doesn’t solve those problems.”
Some Fed policymakers are pushing in a similar direction. They include James Bullard, the president of the Federal Reserve Bank of St. Louis.
“It makes sense to try to move a little bit more hawkishly here and try to manage the inflation risk,” Bullard said in an interview this week on Bloomberg Television. (“Hawkish” refers to Fed policymakers who put a priority on raising rates to fight inflation, while “doves” typically favor keeping rates lower to spur more growth and hiring.)
Many economists have been moving up their timetable for an initial Fed rate hike. Goldman Sachs now foresees two rate increases next year, nearly a year earlier than their previous projections.
Some Fed officials, though, want to take a more patient approach, allowing the taper to continue through June and then taking time to assess whether rate further rate hikes are needed
Mary Daly, who leads the San Francisco Fed, said this week that she understands the difficulties caused by high inflation, particularly for people living paycheck to paycheck. In remarks to a business audience, she said she saw a woman at a Walgreen’s recently removing things from her shopping basket while checking out because they had become too expensive.
Still, Daly said she thought the Fed should continue its current pace of tapering through June, and then, assuming the pandemic steadily loosens its grip on the economy, wait to get a clearer sense of whether inflation will fade.
“Should current high inflation readings and worker shortages turn out to be Covid-related and transitory, higher interest rates would bridle growth, slow recovery in the labor market and unnecessarily sideline millions of workers,” Daly warned.
Furman advocates a more hawkish approach because of the risk that inflation may be driven higher in coming months by factors unrelated to the pandemic, such as higher rents and steady wage increases. Businesses, in turn, may raise prices to offset the cost of higher pay.
More dovish economists counter that the main cause of inflation isn’t a general overheating of the economy, which is normally why the Fed tightens credit. This time, they say, the main factor has been a shift among consumers to spend heavily on goods like furniture, appliances and cars, as the pandemic has kept people at home longer and has limited spending on services such as flying, eating out and attending movies and concerts.
Spending on goods has jumped 15% since the pandemic, economists at Wells Fargo note. After the last recession, goods spending didn’t rise that much until eight years after the downturn began. That powerful demand is clogging ports and overwhelming the freight trains and trucks that deliver them.
Consumers are likely to shift some of that spending back to services as the pandemic fades, which could slow inflation, said Michael Pugliese, an economist at Wells Fargo.
Powell suggested that he was thinking about this very issue during a news conference after the Fed’s recent meeting, when he said consumers will likely shift some spending back to services soon.
The debate is intensifying as Biden nears a decision on whether to reappoint Powell as Fed chair. The president told reporters Tuesday that he would announce his decision as soon as this week.
“With the grace of God and the goodwill of the neighbors, you’re gonna hear that in about four days,” he said.