Why the Fed thinks now is the time to tighten credit faster
Federal Reserve Board Chairman Jerome Powell. AP PHOTO
WASHINGTON DC: For months Federal Reserve Chairman Jerome Powell responded to the spike in inflation by advising patience and stressing that the Fed wanted to see unemployment return to near-pandemic levels before it doesn’t increase interest rates.
But on Wednesday, Powell suggested his patience was running out. High inflation not only persisted, but accelerated to a high of almost four decades. Average wages are increasing. Hiring is solid and unemployment is falling. All of these trends, Powell said at a press conference, have led him and the rest of the Fed’s policymakers to decide that now is the time to step up the Fed’s credit crunch.
The central bank has said it will cut its monthly bond purchases – which are meant to lower long-term rates – to double the pace it previously set and will likely end purchases in March. This accelerated schedule puts the Fed on track to start raising rates as early as the first half of next year.
What’s more, policymakers collectively predict that they will hike their short-term benchmark rate three times next year – a significant increase from September, when the 18 officials were divided over whether to hike. if only once in 2022. The Fed’s key rate, now pinned near zero, influences many consumer and business loans, including mortgages, credit cards and auto loans . The rates on these loans could also start to increase next year.
The policy changes reflect a sharp shift by Powell and the Fed to focus more on fighting inflation and less on reducing unemployment.
At his press conference after the Fed’s last policy meeting, Powell did not say the labor market had fully recovered from the pandemic recession. But he said “rapid progress” had been made towards the Fed’s goal of “maximum employment”. And if inflation is still high next year, he said, the Fed could decide to start raising rates even if the maximum number of jobs has not been reached.
He noted recent economic reports that showed higher inflation, solid wage growth and steady job gains.
“We need to make policy now, and inflation is way above” the central bank’s 2% annual target, Powell said. “With high inflationary pressures and a rapidly strengthening labor market, the economy no longer needs increasing amounts of political support.”
Fed actions could increase borrowing costs across the economy over the next few months, although Fed policy changes do not always immediately affect other borrowing rates. And even if the central bank hiked rates three times next year, that would still leave its benchmark rate at a historically low level, below 1%.
Since the spring, the central bank had characterized inflation as primarily a “transitional” problem that would subside as supply bottlenecks caused by the pandemic were resolved. But at his press conference, Powell admitted that the price spikes have persisted longer than the Fed expected.
Once consumers start to expect inflation to continue, Powell noted, it can make it harder to keep the Fed under control. If households expect higher prices, they tend to demand higher wage increases, which can then lead companies to raise their prices further to offset their higher labor costs.
“There is a real risk now,” said Powell, “that inflation may be more persistent and this may put pressure on inflation expectations, and that the risk of higher inflation taking hold has increased. . I think part of the reason for our decision today is to put ourselves in a position to deal with that risk. “
He said the Fed’s goals of maximum employment and stable prices have been complicated by the unusual dynamics of the pandemic recovery. The Fed had hoped to see inflation rise due to very low unemployment and higher wages, signs of a strong economy. Instead, the surge in inflation is mostly driven by grunts in the supply chain and increased demand for goods like furniture, cars, and appliances.
“The inflation we got,” said Powell, “was not the inflation we were looking at all.”
The price hike lasted longer than the Fed expected, and spilled from goods like food, energy, and automobiles to services like apartment rentals, restaurant meals, and guest rooms. ‘hotel. It took a heavy toll on consumers, especially low-income households and especially for daily necessities, and canceled the higher wages many workers received.
Collectively, Fed policymakers predict on Wednesday that inflation, as measured by their preferred indicator, will hit 5.3% by the end of the year, according to the Fed’s preferred indicator. They expect inflation to slow significantly to an annual rate of 2.6% by the end of 2022. But that’s up from its September forecast of just 2.2%.
Gas prices are already out of their peaks. Supply chain bottlenecks in some regions are gradually easing. And the government’s stimulus payments, which helped spur higher spending that boosted inflation, are not expected to return.
Officials predict the unemployment rate will drop to 3.5% by the end of next year, which would be in line with pre-pandemic levels, when unemployment was at its lowest in 50 years.
Powell said all Fed officials expect the central bank’s target of “maximum employment” to be met sometime next year, and pointed to a rapid drop in the rate. unemployment in the last two months, from 4.8% to 4.2%.
He also noted that job vacancies were at record highs and millions were quitting their jobs, which is usually a sign of a strong job market, in which people find new and better paying positions. Although the proportion of people working or looking for work is still significantly lower than pre-pandemic levels, Powell hoped it could fully recover over time if the economy remains healthy.
“We would in no way want to rule out the idea that the job market may improve further,” even after the Fed has started to hike rates, he said.
The Fed buys $ 90 billion in bonds per month, up from $ 120 billion in October, and had reduced those purchases by $ 15 billion per month. But in January, he will cut those purchases from $ 30 billion, to $ 60 billion, and be on track, Powell said, to end them completely in March.
In addition to three rate hikes next year, Fed officials plan to hike rates three times in 2023 and twice as much in 2024, leaving their benchmark rate at 2.1%, still relatively low historically. .
On Wall Street, stock prices gradually rose, then surged after the Fed released its statement and Powell began speaking at a press conference. By the end of the day, stock averages all rose more than 1%, a substantial gain.