Fed keeps key rate near zero, sees inflation as ‘transitory’

The Fed also signalled its belief that the pandemic’s threat to the economy has diminished, a significant point given Chair Jerome Powell’s long-stated view that the recovery depends on the virus being brought under control. Last month, the Fed had cautioned that the virus posed “considerable risks to the economic outlook.” On Wednesday, it said only that “risks to the economic outlook remain” because of the pandemic.

The central bank left its benchmark short-term rate near zero, where it’s been since the pandemic erupted nearly a year ago, to help keep loan rates down to encourage borrowing and spending. It also said in a statement after its latest policy meeting that it would keep buying $120 billion in bonds each month to try to keep longer-term borrowing rates low.

The U.S. economy has been posting unexpectedly strong gains in recent weeks, with barometers of hiring, spending and manufacturing all surging. Most economists say they detect the early stages of what could be a robust and sustained recovery, with coronavirus case counts declining, vaccinations rising and Americans spending their stimulus-boosted savings.

In March, employers added nearly 1 million jobs — an unheard-of figure before the pandemic. And in April, consumer confidence jumped to its highest level since the pandemic flattened the economy in March of last year.

The quickening pace of growth, on top of additional large spending packages proposed by President Joe Biden, have raised fears among some analysts that inflation, long quiescent, could rise uncomfortably fast. Raw materials and parts, from lumber to copper to semiconductors, have spiked in price as demand has outstripped the ability of suppliers and shippers to keep up.

Some companies have recently said they plan to raise prices to offset the cost of more expensive supplies. They include the consumer products giants Procter & Gamble and 3M as well as Honeywell, which makes industrial and consumer goods. Powell has said he expects supply bottlenecks to lead to temporary price increases, rather than to a prolonged bout of accelerating inflation.

Under a new framework the Fed adopted last summer, it will no longer raise rates in anticipation of high inflation, which had been its policy for decades. Powell and other Fed officials have made clear they want to see inflation actually exceed their 2% annual inflation target — and not just briefly — before they’d consider raising rates.

They’ve set that goal so that inflation would average 2% over time, to offset the fact that it has been stuck below 2% for nearly the entire past decade. Fed policymakers favour price gains at that level as a cushion against deflation — a prolonged drop in prices and wages that typically makes people and companies reluctant to spend.

One reason Powell has said he thinks the inflation pressures building in the U.S. economy will prove temporary is that, for now, most Americans don’t expect prices to rise much in the long run.

Once expectations for inflation do rise, they can be self-fulfilling: workers start demanding higher pay to offset expected price gains, and retailers begin raising prices to offset increased wages and supply costs. This can set off a wage-price spiral, something the United States last experienced in the late 1960s and 1970s.

Apart from inflation, the Fed’s new framework includes a sweeping definition of maximum employment that includes fully recovering the jobs lost to the pandemic, including among many people of colour and low-income workers, before it even considers a rate hike. Powell has also indicated that the Fed would like the roughly 4 million Americans who stopped looking for work after being laid off in the past year to be hired before it considers tightening rates.

The Fed’s policymakers themselves have turned more optimistic about the recovery. Last month, they significantly upgraded their forecasts for growth and inflation. They estimated that the economy will expand 6.5% this year, up sharply from their previous projection in December of 4.2%. And they raised their forecast for inflation by the end of this year from 1.8% to 2.4%.