Fed to start reining in economic aid as inflation risk rises

WASHINGTON, Inflation at its highest level in 30 years, the Federal Reserve will begin to reduce the unprecedented stimulus it has provided to the economy since last year's pandemic recession. This could be a difficult balancing act that can prove risky.

Fed to start reining in economic aid as inflation risk rises

WASHINGTON, Inflation at its highest level in 30 years, the Federal Reserve will begin to reduce the unprecedented stimulus it has provided to the economy since last year's pandemic recession. This could be a difficult balancing act that can prove risky.

Chair Jerome Powell indicated that the Fed would announce, after Wednesday's policy meeting, that it will begin paring $120 billion of monthly bond purchases. This could be as early as this month. These purchases are designed to lower long-term loan interest rates to encourage borrowing and spending.

After the Fed stops buying bonds by mid-2022 it will have to make a difficult decision about when to increase its benchmark short-term interest rate from zero. This is where it has been since March 2020, when COVID-19 devastated the economy. This rate affects many business and consumer loans. It is intended to control inflation. However, it could discourage spending and cause economic problems before the economy has regained its full health.

Grant Thornton's chief economist Diane Swonk stated that "We don’t have a plan for what we’re going through." Powell must "walk a tightrope" and support the recovery, while also not being "deaf to inflation."

In this uncertain background, President Joe Biden has not yet announced whether he will nominate Powell for a fourth-year term as Fed Chair. Powell's term ends in February. However, previous presidents usually announce such decisions in late summer or fall.

Biden is expected offer Powell a second term, despite protests from progressive groups that Powell has increased risks to the financial sector by loosening bank regulations. He is also not sufficiently committed to taking into account the economic dangers from climate change in the Fed’s supervision of financial firms. Powell is highly regarded on Wall Street and within most economic circles. He has been praised for his ability to steer the economy through the recession, in part by using a variety of emergency Fed lending programs.

As high inflation continues to plague the U.S., Powell and other officials had expected, this week's Fed decision to reduce its bond purchases is likely. Consumers' high spending has led to a surge in prices for automobiles, furniture and food .

The government reported Friday that prices rose 4.4% in September compared to a year ago -- the fastest 12-month growth since 1991. However, there was one indicator that inflation may be slowing: Prices rose 0.2% between August and September, excluding volatile food and energy categories. This was a tenth of the increase in the previous month and far less than the 0.6% jump in May.

According to a separate report Friday, salaries and wages rose by the highest level in at least 20 year in the July-September period. This suggests that workers are more able to demand higher wages from businesses who are trying to fill near-record numbers of jobs. If companies increase prices to pay for large increases in wages, it can cause inflation.

Although inflation is high, the job market is not back to its full strength. In September rose 4.4% in September unemployment rate was 4.8%. This is higher than its pre-pandemic 3.5% level. There are 5 million fewer jobs than there were before the pandemic. Many Americans are still waiting to find work. Some of this is because they fear the virus, can't afford child care, or because they want to retire earlier.

Powell stated that he wants the US to see further improvements in the labor market before the Fed raises its key short-term interest rate. Economists believe he will use Wednesday's Fed meeting to emphasize, as before, that the Fed's tapering of its bond purchases does not mean that a rate increase is imminent.

He stated a week ago , "I think it's the right time to taper and I don't believe it's the time to raise rates."

Minutes of the Fed's most recent meeting show that the central bank is likely to reduce its monthly purchases by Treasury and mortgage bonds by $15Billion per month. The Fed could raise rates as quickly as possible by tapering its bond purchases so fast.

It doesn't mean it won't. The Fed's policymakers predicted that the first rate increase would occur in 2022. Half of them projected 2023. However, the Fed will have to decide if inflation is still high and if the Fed believes the job market is in full health before any rate increase can be made.

Powell had expressed optimism earlier in the pandemic about restoring the unemployment rate to pre-COVID levels, when it was at 3.5%, a low that stood for 50 years. However, Powell and other officials expressed doubts that the job market will recover fully in recent years.

It is not clear when or if the millions of Americans who have quit the workforce will return. The newly jobless include those who work or live in areas, such as downtowns, of major urban centers. These places may not be fully reopen for business. The Fed may decide to raise rates sooner if there are many people who have left the job market.

"They need to think now that the labor market has changed in a structural manner," stated Steve Friedman, an economist with MacKay Shields as well as a former senior staffer of the New York Fed.

However, the Fed could raise rates too quickly. In the next few months, supply bottlenecks could ease. The Fed raising rates simultaneously could lead to a drop in spending and a weakening of the economy, just as the supply problem is improving.

Randal Quarles, who is a member of Fed's Board of Governors stated in a speech that "we could easily find demand is dampening just as supply has been increasing." In the worst case scenario, we could reduce the incentive for supply to return, leading a prolonged period of sluggishness.

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