Sun | Sep 19, 2021

Divided Fed to discuss pull-back in economic aid amid inflation spike

Published:Tuesday | July 27, 2021 | 12:08 AM
US Federal Reserve Board Chair Jerome Powell.
US Federal Reserve Board Chair Jerome Powell.

With inflation uncomfortably high and the COVID-19 Delta variant raising economic concerns, a divided US Federal Reserve will meet this week to discuss when and how it should dial back its ultra-low-interest rate policies.

For now, the United States economy is growing briskly in the wake of the pandemic recession, and the pace of hiring is healthy, which is why the Fed’s policymakers will likely move closer toward acting soon. In particular, the officials are expected to discuss the timing and mechanics of slowing their US$120 billion-a-month in bond purchases — a pandemic-era policy that is intended to keep long-term loan rates low to spur borrowing and spending.

This week’s meeting occurs against the backdrop of a risky policy bet by Fed Chair Jerome Powell. Powell is gambling that the central bank can engineer an exceedingly delicate task: To keep the Fed’s short-term benchmark rate pegged near zero, where it has been since March 2020, until the job market has fully healed, without fuelling a sustained bout of high inflation.

Yet the stakes around that bet are rising, with consumer prices having jumped 5.4 per cent in June from a year ago, the biggest increase in 13 years. Last month’s surge marked a fourth straight month of unexpectedly large price increases, heightening fears that persistently higher inflation will erode the value of recent pay raises and undermine the economic recovery.

The main concern is that the Fed will end up responding too late and too aggressively to high inflation by quickly jacking up interest rates and perhaps causing another recession. Last week, Republicans in Congress peppered Powell with questions about inflation, for which they largely blamed President Joe Biden’s US$1.9 trillion stimulus package, which was enacted in March.

In his testimony, Powell largely stood by his view that higher inflation will prove temporary. His reasoning is that recent high price increases — for things like used and new cars, hotel rooms and airline tickets — have been driven mainly by supply shortages related to the swift reopening of the economy. But he also stated more explicitly than before that the Fed won’t hesitate to raise rates should it decide that inflation is getting out of control.

After a period of broad agreement during the pandemic crisis, the Fed’s policymakers appear divided over how soon to start reducing — or “tapering,” in Fed parlance — its monthly bond purchases. Several regional Fed bank presidents support tapering soon, including James Bullard of the St Louis Fed, Patrick Harker of the Philadelphia Fed and Robert Kaplan of the Dallas Fed.

Powell has said that the central bank wants to see “substantial further progress” toward its goals of maximum employment and price stability before it would consider reducing the bond purchases. To make up for years of inflation remaining below 2 per cent, Powell said, the Fed wants inflation to moderately exceed its 2 per cent average inflation target and to show signs of remaining above it for an unspecified time. In recent months, as consumer demand has exceeded the supply of goods and services in some industries, inflation has topped 2 per cent.

Powell suggested during his congressional testimony last week that the economy was “still a ways off” from achieving that progress. On Wednesday, when the Fed issues a policy statement and Powell holds a news conference, any signal that such progress is near could mean that the Fed is getting closer to reducing its bond purchases.

“The economy is, bottom line, much better than it was a year ago,” said Nathan Sheets, chief economist at PGIM Fixed Income and a former director of international finance at the Fed. “It is getting harder and harder for the Fed to explain why it needs to keep buying US$120 billion of assets a month,” he said.