– With soaring inflation, falling unemployment and rising wages, some economists warn the Federal Reserve may have waited too long to reverse its ultra-low rate policies – a delay that could expose the economy at increased risk.
On Wednesday, the government is expected to report that consumer prices have jumped 7.1% in the past 12 months, believed to be the biggest such increase in decades. Fed Chairman Jerome Powell will certainly be grilled on the issue during a Senate hearing today on his appointment for a second four-year term. Inflation has become the most serious threat to the economy, a growing concern for financial markets, and a major political problem for the Biden administration and Democrats in Congress.
While Powell has many supporters applauding the Fed’s willingness to keep interest rates low to help reduce unemployment after the pandemic recession, Friday’s U.S. jobs report for December has sounded l ‘alarm. It showed another sharp drop in the unemployment rate, an unexpected increase in hourly wages and chronic labor shortages.
While lower unemployment and higher wages benefit workers, they can also fuel higher prices. The jobs report has led many economists to forecast more interest rate hikes this year than they previously predicted as the Fed scrambles to manage a rapidly changing economy. The Fed is now expected to start raising rates in March – a move which, in turn, would increase borrowing costs for many consumers and businesses.
By waiting as long as it has, the Fed could eventually be forced to step up its rate hikes, pushing harder on the economic brakes. Still, it could slow growth, disrupt financial markets and potentially trigger a recession. Many past recessions have been caused by aggressive Fed rate hikes aimed at fighting or preventing inflation.
Last month, in a sharp turn towards fighting inflation, the Fed signaled that it planned to raise its short-term benchmark rate, currently close to zero, three times this year. As late as September, policymakers were divided over whether to raise rates even once in 2022.
“There is a substantial risk that the Fed will be late enough that it will face the challenge of letting inflation stay persistently high or risk a recession,” said Tim Duy, chief US economist at SGH Macro Advisors .
Stocks have fallen and bond yields have surged since the minutes of the December Fed meeting, released last week, showed officials are likely to act faster to tighten credit.
Many economists now expect the Fed to raise its key rate at least four times this year. And according to the minutes of its December meeting, Fed officials also plan to move faster to get rid of the nearly $ 8.8 trillion in Treasury and mortgage bonds they hold, a move that would also tighten credit. The minutes said policymakers could start letting those holdings decline, as the securities mature, soon after the Fed’s first rate hike.
For now, the Fed’s policies mainly reflect the emergency parameters that have been put in place since the pandemic hit in March 2020. In addition to pegging rates at virtually zero, the Fed is still buying bonds. to try and maintain rates over the long term. These bond purchases are expected to end in March.
Yet on Friday the government announced that the unemployment rate fell in December to 4.2% from 3.9% in November and was down from 6.7% a year earlier – the fastest drop 12-month unemployment rate since the record began in 1948. (This followed the largest unemployment increase on record in 2020.)
With the decrease in the number of unemployed, companies have been forced to increase hourly wages to retain and attract workers. In the last three months of 2021, wages have jumped at an annual rate of 6.2%. And for workers in restaurants, hotels and casinos, wages soared 14.1% in December from a year ago.
“Normally, the Fed would have hiked rates long before,” Duy said. “The fact that we have barely started suggests that the Fed misjudged how quickly the economy was going to come back on line.”
However, some economists defend the Fed’s approach. They echo the central bank’s view that inflation is likely to decline this year as the pandemic abates. According to this view, the surge in spending on goods, from cars to Platoons, will fade as Americans return to spending on travel and dining out. This will allow bottlenecks in the supply chain to dissipate, thereby reducing the prices of goods.
And, they argue, the Fed’s willingness to keep rates low, even as the economy recovers, has helped sustain a faster pace of growth and hiring, especially compared to the extremely slow recovery after. the 2008-2009 recession.
“The Fed is closer to the schedule than making a mistake,” said Skanda Amarnath, executive director of Employment America. “It’s easy for a Monday morning quarterback to say the Fed should have done more last year. But it would have risked leaving too many people out of work. Even now, the economy has 3.6 million fewer jobs than before the pandemic.
Still, many economists argue that the Fed remains overly optimistic about inflation and that the rate will stay well above the Fed’s 2% inflation target this year.
“What is currently expected in terms of what the Fed will do in 2022 is far too little,” said Jon Steinsson, professor of economics at the University of California at Berkeley.
Steinsson spoke on Saturday at an inflation panel discussion at the American Economic Association’s annual meeting. Steinsson noted that adjusted for inflation, interest rates are in negative territory despite the rapid progress of the economy.
“I think it’s just too low,” he said.
The three economists on Saturday’s panel – Steinsson; Jason Furman, Harvard economist and former senior adviser to President Barack Obama; and Joseph Gagnon, a senior researcher at the Peterson Institute for International Economics and a former Fed economist, said they believe inflation, according to the Fed’s preferred measure, will stay at at least 3.5% by the end of the year. end of the year. The Fed believes it will fall to 2.6%.
Powell has often said that if the pandemic wears off, inflation will drop as supply chains unravel and more people take jobs. But Furman argued that other trends will offset some of these benefits. Once cases of COVID-19 decline, he said, people will likely drive more and push gas prices up. And as with previous reopenings of the economy, the prices of hotel rooms, plane tickets and rental cars could climb.
The Fed had hoped more people would start looking for work again once improved unemployment assistance ended nationwide in September. Schools also reopened that month, potentially freeing more women to return to work after caring for their children during online school. Yet this influx of workers did not take place. There are still 2.2 million fewer people working or looking for work than before the pandemic.
Instead, desperate demand for corporate workers – with job vacancies close to a November record of 10.6 million – pushed wages up sharply.
A higher salary should allow for more spending, keeping upward pressure on prices, Furman said. And the rents are now increasing rapidly.
Gagnon said on Saturday that the Fed was being overly cautious in part because it is too concerned about preparing financial markets for policy changes, particularly after 2013. At the time, in an episode known as the “banging down” tantrum, “Chairman Ben Bernanke unexpectedly said that the Fed would soon cut back on bond purchases in which he was engaged, a remark that caused fluctuations in the prices of stocks and bonds.
“They were marked by the tantrum,” said Gagnon. “I think they’ve gone too far to the other side to try to play down surprising markets.”
Gagnon also defended the Fed, noting the complexity of the economy during the pandemic.
“It seems incredibly slow what they’re doing, but they’re turning a supertanker, they’re communicating with the markets, they’re moving in the right direction, it’s clear they’re focusing on the right things,” he said. .
The Fed can also speed up its credit crunch if necessary, Gagnon said.
“If we’re right about our inflation concerns, they’ll make more than three rate hikes this year,” he said.