Federal Reserve officials spoke with one voice throughout the pandemic downturn, promising that monetary policy would be set to full-stimulus mode until the crisis was well and truly behind the United States. Suddenly, they are less in sync.
Central bankers are increasingly divided over how to think about and respond to emerging risks after months of rising asset values and faster-than-expected price increases. While their political counterparts in the White House have been more unified in maintaining that the recent jump in price gains will fade as the economy gets past a reopening burst, Washington as a whole is wrestling with how to approach policy at a moment of intense uncertainty.
The Fed’s top officials, including chair Jerome Powell, acknowledge that a lasting period of uncomfortably high inflation is a possibility. But they have said it is more likely that recent price increases, which have come as the economy reopens from its coronavirus slumber, will fade.
Other officials, like James Bullard, president of the Federal Reserve Bank of St. Louis, have voiced more pointed concern that the pickup in prices might persist and have suggested that the Fed may need to slow its support for the economy more quickly as a result.
Unwanted and persistent inflation seemed like a fringe possibility earlier this year, but it is becoming a central feature of economic policy debates as prices rise for used cars, airline tickets and restaurant meals. For the Fed, the risk that some of the current jump could last is helping to drive the discussion about how soon and how quickly officials should slow down their enormous government-backed bond-buying program – the first step in the central bank’s plan to reduce its emergency support for the economy.
Fed officials have said for months that they want to achieve “substantial further progress” toward their goals of full employment and stable inflation before slowing the purchases, and they are just beginning to discuss a plan for that so-called taper. They are now wrestling with the reality that the country is still missing 7.6 million jobs while the housing market is booming and prices have moved up faster than expected, prompting a range of views to surface in public and private.
The bubbling debate reinforces that the central bank’s easy money policies won’t last forever, and sends a signal to markets that officials are closely attuned to inflationary pressures.
“I see the debate and disagreement as the Fed at its best,” said Robert S. Kaplan, who is president of the Federal Reserve Bank of Dallas and is one of the people pushing for the Fed to soon begin to pull back support. “In a situation this complex and this dynamic, if I weren’t seeing debate and disagreement, and there were unanimity, it would make me nervous.”
The central bank’s 18 policy officials roundly say that the economy’s path is extremely hard to predict as it reopens from a once-in-a-century pandemic. But how they think about inflation after a string of strong recent price reports – and how they feel the Fed should react – varies.
Inflation has spiked because of statistical quirks, but also because consumer demand is outstripping supply as the economy reopens and families open their wallets for dinners out and long-delayed vacations. Bottlenecks that have held up computer chip production and home building should eventually fade. Some prices that had previously shot up, such as those for lumber, are already starting to moderate.
But if the reopening weirdness lasts long enough, it could cause businesses and consumers to anticipate higher inflation permanently, and act accordingly. Should that happen, or if workers begin to negotiate higher wages to cover the pop in living costs, faster price gains could stick around.
“A new risk is that inflation may surprise still further to the upside as the reopening process continues, beyond the level necessary to simply make up for past misses to the low side,” Mr. Bullard said in a presentation last week. The Fed aims for 2-per-cent inflation as an average goal over time, without specifying the time frame.
Other Fed officials have said today’s price pressures are likely to ease with time, but have not sounded confident that they will entirely disappear.
“These upward price pressures may ease as the bottlenecks are worked out, but it could take some time,” Michelle Bowman, one of the Fed’s Washington-based governors, said in a recent speech.
The Fed’s top leadership has offered a less alarmed take on the price trajectory. Mr. Powell and John C. Williams, president of the Federal Reserve Bank of New York, have said it is possible that prices could stay higher, but they have also said there’s little evidence so far to suggest that they will.
“A pretty substantial part – or perhaps all – of the overshoot in inflation comes from categories that are directly affected by the reopening of the economy,” Mr. Powell said during congressional testimony on June 22.
Mr. Williams has said there is even a risk that inflation could slow. The one-off factors pushing up prices now, such as a surge in car prices, could reverse once supply recovers, dragging down future price gains.
“You could see inflation coming in lower than expected,” he said last week.
Which take on inflation prevails – risk-focused, watchful or less fretful – will have implications for the economy. Officials are beginning to talk about when and how to slow down their US$120-billion in monthly bond buying, which is split between US$80-billion in Treasury securities and US$40-billion in government-backed mortgage debt.
The Fed has held a discussion about slowing bond buying before, after the global financial crisis, but that came during the rebound from a deep but otherwise more standard downturn: Demand was weak and the labour market climbed slowly back. This time, conditions are much more volatile since the recession was an anomaly, driven by a pandemic instead of a financial or business shock.
In the current setting, officials who are more worried about prices getting out of hand may feel more urgency to dial back their economic stimulus, which stokes demand.
“This is a volatile environment; we’ve got upside inflation risk here,” Mr. Bullard said at a separate event last week. “Creating some optionality for the committee might be really useful here, and that will be part of the taper debate going forward.”
Mr. Kaplan said he had been vocal about his preferences on when tapering should start during private Fed discussions, though publicly he will say only that he would prefer to start cutting policy support “sooner rather than later.”
He thinks moving more quickly to slow bond purchases would take a “risk management” approach to both price gains and asset market excess: reducing the chances of a bad outcome now, which might mean the Fed doesn’t have to raise interest rates as early down the road.
Several officials, including Mr. Kaplan and Mr. Bullard, have said it might be wise for the Fed to slow its purchases of mortgage debt more rapidly than they slow bond buying over all, concerned that the Fed’s buying might be contributing to a hot housing market.
But even that conclusion isn’t uniform. Lael Brainard, a Fed governor, and Mary C. Daly, president of the Federal Reserve Bank of San Francisco, have suggested that the mortgage-backed purchases affect financial conditions as a whole – suggesting they may be less keen on cutting them back faster.
The price outlook will also inform when the Fed first raises interest rates. The Fed has said that it wants to achieve 2-per-cent inflation on average over time and maximum employment before lifting borrowing costs away from rock bottom.
Rate increases are not yet up for discussion, but Fed officials’ published forecasts show that the policy-setting committee is increasingly divided on when that liftoff will happen. While five expect rates to remain unchanged through late 2023, opinions are otherwise all over the place. Two officials see one increase by the end of that year, three see two, three see three and another three see four. Two think the Fed will have raised rates six times.
Both Fed policy debates will affect financial markets. Bond buying and low rates tend to pump up prices on houses, stocks and other assets, so the Fed’s pullback could cause them to cool off. And they matter for the economy: If the Fed removes support too late and inflation gets out of control, it could take a recession to rein it in again. If it removes its help prematurely, the slowdown in demand could leave output and the labour market weak.
The Fed will be working against a changing backdrop as it tries to decide what full employment and stable prices mean in a postpandemic world. More money from President Joe Biden’s US$1.9-trillion economic aid bill will soon begin to flow into the economy. For example, the Treasury Department in July will begin depositing direct monthly payments into the accounts of millions of parents who qualify for an expanded child tax credit.
But expanded unemployment insurance benefits are ending in many states. That could leave consumers with less money and slow down demand if it takes would-be workers time to find new jobs.
As the trends play out, White House officials will also be watching to see whether the economy is hot or not. The administration is trying to pass a follow-up fiscal package that would focus on longer-term investments, and Republican opposition has centred partly on inflation risks.
For Mr. Kaplan at the Fed, the point is to be watchful. He said it was important to learn from the lessons of the post-2008 crisis recovery, when monetary policy support was removed before inflation had meaningfully accelerated – but also to understand that this rebound is unique.
“Realizing that this is a different situation is a wise thing,” Mr. Kaplan said.
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