Federal Reserve officials spoke with one voice throughout the downturn in the pandemic, pledging that monetary policy would be set to full stimulus mode until the crisis clearly lagged America. Suddenly they are less in sync.
After months of soaring assets and faster-than-expected price hikes, central bankers are increasingly divided on how to think about and respond to emerging risks. While her political counterparts in the White House agreed that the recent surge in price gains will fade once the economy has reopened, Washington as a whole wrestles with how to approach politics in a moment of intense uncertainty.
Top Fed officials, including Chairman Jerome H. Powell, admit that a prolonged period of uncomfortably high inflation is possible. However, they have said that it is more likely that the recent price hikes that have come with the economy reopening from coronavirus slumber will ease off.
Other officials, such as James Bullard, president of the Federal Reserve Bank of St. Louis, expressed greater concern that the price hike could continue and suggested that the Fed may need to slow down its support to the economy more quickly as a result.
Unwanted and persistent inflation appeared to be marginal earlier this year, but it is becoming a central theme of economic policy debates as the prices of used cars, plane tickets and restaurant meals rise. For the Fed, the risk that part of the current jump could last is helping fuel the discussion about how quickly and how quickly officials should slow down their massive government-sponsored bond-buying program – the first step in the central bank’s plan to reduce it his emergency aid for the economy.
Fed officials have said for months that they want to make “significant further progress” towards their goals of full employment and stable inflation before slowing buying, and they are just beginning to discuss a plan for this so-called taper. They are now grappling with the reality that the country is still 7.6 million job shortages while the housing market is booming and prices have risen faster than expected, which has sparked a range of public and private views.
The simmering debate reinforces that central bank monetary policy will not last forever and sends a signal to markets that officials are alert to inflationary pressures.
“I see the debate and disagreement as the Fed at its best,” said Robert S. Kaplan, president of the Federal Reserve Bank of Dallas and one of the people who are pushing for the Fed to begin withdrawing support soon. “In such a complex and dynamic situation, it would make me nervous if I didn’t see debates and disagreements and if there was no unanimity.”
The central bank’s 18 political officials all round say that the path of the economy is extremely difficult to predict as it reopens after a century of pandemic. But how they think about inflation – and how they think the Fed should react – after a series of strong price reports recently – varies.
Inflation has soared on statistical quirks, but also because consumer demand outpaces supply as the economy reopens and families open their wallets for dinners and long-postponed vacations. Bottlenecks that have hampered computer chip production and housing construction should eventually go away. Some previously soaring prices, such as those for sawn timber, are already beginning to moderate.
But if the reopening craze lasts long enough, it could result in businesses and consumers constantly anticipating higher inflation and acting accordingly. Should that happen, or if workers start negotiating higher wages to cover the cost of living, faster price increases could persist.
“A new risk is that inflation could surprise even higher as the reopening process continues, beyond the level required to easily make up for past failures on the low side,” Bullard said in a presentation last week. As an average target, the Fed is aiming for inflation of 2 percent over time, without setting the time frame.
Other Fed officials said today’s price pressures are likely to ease over time, but didn’t sound confident it will go away completely.
“This upward pressure on prices could ease once the bottlenecks are removed, but it could take time,” said Michelle Bowman, one of the Fed’s governors in Washington, in a recent speech.
The top management of the Fed was less concerned about the share price development. 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 that there is little evidence so far to suggest that it is will be.
“Pretty much – or perhaps all – of the inflation overshoot comes from categories directly affected by the reopening of the economy,” Powell said during the June 22nd Congressional hearing.
Mr Williams said there was even a risk that inflation could slow down. The one-off factors that are now driving prices up, such as a spike in car prices, could reverse once supply rebounds and depress future price gains.
“Inflation could be lower than expected,” he said last week.
Whichever inflationary stance prevails – risky, vigilant, or less concerned – will have an impact on the economy. Officials are starting to speak about when and how they can slow their monthly bond purchases of $ 120 billion, which is split between $ 80 billion in government bonds and $ 40 billion in government-backed mortgage loans.
The Fed had a discussion about a slowdown in bond buying before and after the global financial crisis, but it came from a deep but otherwise more common downturn during the recovery: demand was weak and the labor market slowly recovered. This time around, conditions are much more volatile as the recession was an anomaly driven by a pandemic rather than a financial or business shock.
In the current situation, officials more concerned that prices are getting out of hand may feel more urgent to cut back their economic incentives, which will fuel demand.
“This is a volatile environment; We have upside inflation risk here, ”Bullard said at a separate event last week. “Here it could be very useful to create some optionality for the committee, and that will be part of the future Taper debate.”
Mr Kaplan said he was vocal about his preferences for starting the throttling during private Fed talks, though he will only publicly say that he would prefer to cut policy support “sooner rather than later.”
He believes that a faster move towards slower bond purchases would require a “risk management” approach to both price gains and asset surpluses: lowering the likelihood of a bad result now, which could mean the Fed won’t cut rates this early must increase down the road.
Several officials, including Mr Kaplan and Mr Bullard, have said it might be wise for the Fed to slow its mortgage debt purchases faster than buying bonds overall, as they are concerned that the Fed’s purchases will become a hot real estate market could contribute to the market.
But even this conclusion is not 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 are having an impact on the overall financial condition – suggesting they may be less interested in them to shorten faster.
The price outlook will also provide information on when the Fed will raise rates for the first time. The Fed has announced that it wants to hit 2 percent average inflation and maximum employment over time, before the cost of borrowing hits rock bottom.
Interest rate hikes are not yet up for discussion, but the Fed’s published forecasts show that the Monetary Policy Committee is increasingly divided as to when that rebound will occur. While five assume rates will remain unchanged through the end of 2023, otherwise, opinions are everywhere. Two officials see an increase by the end of the year, three see two, three see three, and three others see four. Two believe the Fed will have hiked rates six times.
Both of the Fed’s policy debates will have an impact on financial markets. Bond purchases and low interest rates tend to drive the prices of homes, stocks, and other assets soaring that the Fed’s withdrawal could cool off. And they matter to the economy: if the Fed breaks support too late and inflation spins out of control, it could take a recession to contain it again. If it cuts aid prematurely, the slowdown in demand could weaken production and the labor market.
The Fed will work in a changing context to decide what full employment and stable prices mean in a post-pandemic world. More money from President Biden’s $ 1.9 trillion Economic Aid Act will soon be pouring into the economy. For example, in July the Treasury Department will begin sending monthly direct payments to the accounts of millions of parents who are eligible for an extended child tax credit.
However, in many states, extended unemployment insurance benefits are ending. This could result in consumers having less money and holding back demand when potential workers need time to find new jobs.
As the trends emerge, White House officials will also be monitoring whether the economy is hot or not. The government is trying to pass a follow-up package that would focus on longer-term investment, and the Republican opposition has focused in part on inflation risks.
Mr Kaplan at the Fed has to be vigilant. He said it is important to learn from the lessons of the post-2008 crisis recovery, when monetary support was lifted before inflation accelerated significantly – but also to understand that this recovery is unique.
“Realizing that this is a different situation is a smart thing,” said Mr. Kaplan.