The Federal Reserve helped blunt the worst of COVID’s damage to the economy by slashing interest rates, steadying the inner workings of the financial system, and vowing to do whatever was needed to prevent the crisis from spiraling out of control.
Now comes another tough assignment: Tame inflation without jeopardizing the recovery.
On Wednesday, central bank officials made clear they wouldn’t respond rashly to prices that are rising at the fastest rate since 1991. Inflation is being fueled by temporary forces that will likely retreat next year, they said in a statement, giving them leeway to keep interest rates pinned near zero in the hopes that unemployment will fall further.
“There is still ground to cover to get to maximum employment,” Fed chairman Jerome Powell said during a news conference after policy makers wrapped up their two-day meeting. “We don‘t want to stop now.”
The US jobless rate was 4.8 percent in September, compared with 3.5 percent in February 2020, just before COVID hit, and there are still 3.3 million fewer jobs than there were then.
The Fed, as expected, said it would begin to reduce the $120 billion a month it has been pumping into the financial system — using purchases of Treasury bonds and mortgage securities — to offset the impact of COVID. It will cut purchases by $15 billion this month and another $15 billion in December.
Barring any unexpected change in economic conditions, that gradual stepdown would continue until the program is finished in June. The Fed said the move, known as tapering, was appropriate given “the substantial further progress the economy has made toward the Committee’s goals since last December.”
The Fed left the target range for its benchmark interest rate unchanged at 0 to 0.25 percent, where it has stood since the onset of the pandemic. Economists said the Fed most likely wouldn’t raise rates until the bond-buying program is over.
In the late 1970s, Congress explicitly charged the Fed with maintaining moderate interest rates while promoting full unemployment and stable prices. But in the past few years, officials have sought to err on the side of maximizing job growth, a position Powell reinforced Wednesday even as he acknowledged the tradeoff meant Americans would be paying higher prices for food, energy, and other essentials for some time.
“The Fed has changed so much,” said Claudia Sahm, a former Fed and White House economist who is now a consultant and senior fellow at Jain Family Institute. “They are finally rising to the challenge of their dual mandate.”
Powell’s job has been complicated by the Delta wave of the pandemic, which has knotted up the economy. Growth slowed in the third quarter to an annualized rate of 2 percent from a sizzling 6.7 percent in the previous three months.
Meanwhile, free-spending consumers, supply-chain snarls, and wage hikes combined to light a flame under inflation. The Fed’s preferred inflation gauge, which strips out volatile food and energy prices, jumped 3.4 percent in September from a year earlier, the most since 1991.
The Fed aims to keep prices from rising more than 2 percent a year over the longer haul. The measure it tracks closely, called core personal consumption expenditures, has climbed an average of 3.6 percent over the past five months, a surge Powell has said was caused by the pandemic-induced disruption to the production and delivery of goods.
“Supply chain problems will abate,” though well into next year, he said. “Inflation will come down.”
Still, the Fed’s statement hedged Powell’s prediction, according to Ken Matheny, executive director of US economics at IHS Markit. The statement noted that the factors driving inflation “are expected to be transitory.” In statements earlier this year, the Fed declared unequivocally that inflationary pressures were transitory.
This bout of inflation has persisted longer than the Fed and most private economists expected six months ago before the emergence of Delta meant all bets were off. (”Have no fear: This inflation is temporary,” was the headline on the column I wrote on the topic in May.)
Delta has also upended the job market, and the Fed isn’t sure yet whether it’s possible to return to February 2020 employment levels in a post-COVID economy where millions of people have quit the workforce. Maximum employment is a moving target with no concrete definition.
“There is no single measure that represents Powell’s or the committee’s view,” Matheny said.
However it ends up deciding what’s full employment, the Fed won’t be able to deliver it on its own. Mark Zandi, chief economist at Moody’s Analytics, said future growth will hinge on Congress passing some form of President Biden’s spending package for social programs, climate change, and physical infrastructure.
“The legislation will also be critical to the economy’s longer-term prospects, long after the pandemic is behind us,” he told clients in a note this week.