What’s more important: expectations that consumer prices (food, health care, housing) and business costs (wages and the like) are going to jump or that they already have, to the point where inflation is spiking?
It’s the latter, if you’re the Federal Reserve, at least since the Great Recession.
It was once a pillar of central bank policy that officials had to boost interest rates preemptively to keep the economy from overheating. Otherwise it would be too late. Any hint of wages rising too quickly, or of investors and consumers starting to behave as if inflation was lurking around the corner — that was often enough to get the Fed to act.
The Fed’s new mantra is patience: Officials in Washington and at its regional banks around the country are saying they will wait until their 2 percent annual inflation target is achieved — on a sustained basis, not just for a few months — and unemployment drops back closer to pre-pandemic levels, or below 4 percent.
“The emphasis on actual outcomes rather than forecasts of rising inflationary pressures when setting monetary policy appears justified,” Eric Rosengren, president of the Federal Reserve Bank of Boston, said on Wednesday.
Consumer prices will probably rise more than 2 percent in coming months as the economic recovery builds speed, but the pickup in inflation should be temporary, one driven mostly by pandemic-related forces that will recede over time, Rosengren told a virtual seminar hosted by Boston College. That’s not just the Fed’s view; the consensus of about 50 private forecasters is for inflation to run between 2.1 percent and 2.5 percent this year.
Fueling the increase: supply disruptions, stronger consumer spending after months of pent-up demand, and rising costs for oil and other commodities.
“My view is that this acceleration in the rate of price increases is likely to prove temporary,” he said. “To date, inflation expectations and the underlying inflation rate look to be stable.”
The question of how quickly and how high prices rise is a central concern of economists and investors amid widespread forecasts for an economic boom fueled by the easing of COVID-19 restrictions and trillions of dollars in federal stimulus spending. If inflation exceeds the Fed’s target for too long, the central bank would be under pressure to boost interest rates.
Most Fed forecasters expect rates to remain near zero through 2023. The private economists aren’t so sure.
The consensus inflation forecast for 2022 is 2 percent, but a fair number of these economists see a meaningful increase in prices above that level next year.
Treasury Secretary Janet Yellen, Powell’s predecessor at the Fed, sent ripples through financial markets on Tuesday when she said in a prerecorded presentation to The Atlantic’s Future Economy Summit that rates might have to rise if President Biden’s $4 trillion in spending plans make it through Congress. Stock prices fell and the yields on long-term government bonds rose.
But the markets recovered after she later told the Wall Street Journal that she was neither predicting nor recommending a rate hike.
Rosengren, who is not a voting member of the Fed’s rate-setting committee this year, is optimistic that economic growth and employment will rise rapidly in 2021 without inflation getting out of hand.
“Toilet paper and Clorox were in short supply at the outset of the pandemic, but manufacturers eventually increased supply, and those items are no longer scarce,” he said. “Many of the factors raising prices this spring are also likely to be similarly short-lived.”
Still, he said Fed policy makers “will need to be vigilant, watching that the post-pandemic environment does not bring structural changes with implications for inflation. It will be particularly important to see whether wages and prices continue to be relatively unresponsive to a tightening labor market.”
Hourly wage growth in the private sector rose above 6 percent during the pandemic, from about 3 percent before COVID-19 hit, and has since settled back in recent months to about 5 percent. But that reflected a significant change in the makeup of the US workforce, with millions of low-wage jobs in consumer-facing businesses disappearing, while higher-paid workers were able to work remotely.
Rosengren noted that the Employment Cost Index, a government measure that adjusts for such labor market changes, has been stable throughout the pandemic. And he said that recent gains in consumer prices were exaggerated by a rise in energy prices from very low levels caused by the pandemic.
He ended his presentation with a note of caution about the recovery, reiterating his concern that millions of Americans remain out of work.
“While rapid economic growth is very good news, it was, and still is, badly needed to offset the sizable shock that occurred with the COVID-19 pandemic,” he said.
Getting everyone back to work will require the Fed to hold rates low for a long while. That has raised expectations for inflation. Will it spark actual inflation?
“The debate about whether trend inflation will rise as the economy strongly recovers . . . will not be answered until next year,” Rosengren said.