The Fed maps faster rates away from unique stimulus

The Federal Reserve is swinging hard from a patient approach to withdrawing support for the US economy.

Fed officials on Wednesday mapped a much faster return from the unique stimulus they deployed at the start of the coronavirus pandemic than they had originally planned. The bank’s policy committee announced that it would complete its monthly purchases of government bonds and mortgage bonds by March, and expects to raise interest rates approximately three times by the end of 2022.

The Fed has managed to reduce the stimulus even though inflation rose for much of this year. Millions of workers remained on the sidelines for more than a year, and officials were reluctant to cut support, expecting more Americans to return to work as the pandemic subsided and fiscal stimulus faded.

But Fed officials have acknowledged that they no longer have time to endure a mass return to the labor market with inflation reaching its highest level in more than 40 years.

“The reality is that we do not have a strong recovery in labor force participation yet, and we may not have it for a while,” the Fed leader Jerome PowellJerome Powell Get ready for a bigger-than-expected rate hike in 2022 The Hill’s Morning Report – Presented by Charter Communications – Dem wheels spin on BBB train; Fed rate hikes in ’22 On The Money – Presented by Citi – Manchin stop leaves Biden bill on the brink of collapse MORE said at a press conference on Wednesday after the December meeting of the Federal Open Market Committee (FOMC), which sets monetary policy.

“At the same time, we must make policy now and inflation is well above target. So this is something we have to take into account, he continued.

By cutting interest rates to near-zero levels in March 2020, buying trillions of dollars in bonds and putting billions into emergency loans, the Fed contributed to a surprisingly strong recovery after the worst economic shock of a century. Unemployment fell to 4.2 per cent in November, growth is set to exceed 5 per cent, and redundancies have fallen to their lowest level in more than 50 years.

The Fed’s response – along with more than $ 5 trillion in fiscal stimulus and the breakthrough of mRNA coronavirus vaccines – was a key force behind a much faster recovery than many economists expected.

Nevertheless, the pace of this upswing has overwhelmed supply chains with intense demand for goods and created higher inflation. At the same time, occupational participation remains 1.5 percentage points below the level before the pandemic.

Usually after a big economic shock, «there are not enough jobs and people can not find jobs, and we stimulate demand and try to get the demand to come up. That’s not the problem here. The problem is a problem on the supply side, Powell said Wednesday.

Consumption spending has risen above pre-pandemic levels, but is still disproportionately focused on goods instead of services and activities with more face-to-face exposure. As spending increased in the face of the virus, manufacturers, suppliers, shipping companies and retailers steadily increased prices while being hampered by bottlenecks, shortages of raw materials and components and staffing problems in critical industries.

As inflation rose, the Fed had faced increasing pressure from Republican lawmakers and even some prominent Democrats, such as former Treasury Secretary Larry Summers, to stop the stimulus before the economy began to overheat. But Powell and Fed officials had called for patience in the face of what they called “transient” inflation, insisted on supply chain tightening and the lagging pandemic-driven labor force participation would soon begin to ease.

“[The Fed] could have been right if the supply side of the economy was able to react faster and stronger, “said Adam Ozimek, chief economist at Upwork, who warned in June that the bank could face pressure as stimulus demand met supply constraints.

“It is clear that the fiscal stimulus pushed demand faster than the economy could handle and kept it tilted towards the more inflationary commodity sector,” he continued.

Powell, like many economists, has acknowledged drastically underestimating how long pandemic-related supply problems will last and how high they will increase inflation.

Inflation measured by the Ministry of Trade’s index of personal consumption expenditure excluding food and energy prices – the Fed’s preferred measure for inflation – rose 0.4 per cent in October and 4.1 per cent annually.

The median estimate among FOMC officials for inflation at the turn of the year rose to 4.4 percent, according to estimates released on Wednesday, up from an estimate of 3.7 percent in September.

“It’s clear they’re paying attention,” said Christopher Russo, a fellow at George Mason University’s Mercatus Center, a libertarian think tank.

“Inflation has obviously held up well to what forecasters in the Fed and in the private sector and elsewhere have predicted, and therefore they are adjusting their policies.”

Powell said on Wednesday that although he had hoped that labor market participation would pick up as federal unemployment benefits expired and schools reopened, the United States now faces the risk of stimulating an economy that quickly reaches its maximum potential during the pandemic.

The Fed chief said that a number of strong job reports in September, large increases in revenues and sharp increases in consumer prices led to concerns that inflation rose outside the pandemic’s grip.

“The risk of higher inflation sticking has increased,” Powell said, adding that it “is not high at the moment.”

“Part of the reason behind our move today is to put ourselves in a position to deal with that risk,” he continued.

After forcing Powell’s hand, the ongoing pandemic could still throw a new wrench into the Fed’s pivot.

Economists are still uncertain about how the emergence of the omicron variant may affect the pace of the rise and inflation. While the delta variant slowed job growth, especially in service industries, inflation rose sharply as consumers with cash flows returned to purchasing goods.

A steep coronavirus-driven decline in consumer activity could take some pressure off inflation and allow the Fed to move more slowly. Several bottlenecks in the supply chain could push the Fed in the opposite direction.

“I’m not worried that the Fed is going to cause a recession. I’m worried that the Fed is going to slow things down,” Ozimek said.

“And after decades of the Fed relying on slowing things down too much. I’m worried about more of that. I think we need to be in a hurry and get back to full employment.