Fed Decision: Officials Project Three Interest Rate Rises in 2022 and Accelerate Stimulus Wind Down

From the Wall Street Journal, 12/15/21:

Most Federal Reserve officials signaled Wednesday they were prepared to raise their short-term benchmark rate at least three times next year to cool high inflation.

As expected, officials also approved plans to more quickly scale back the Fed’s pandemic stimulus efforts in response to hotter inflation, opening the door to rate increases starting next spring.

Fed officials voted to hold rates near zero on Wednesday, but the latest projections are a significant shift from just three months ago. In September, around half of those officials thought rate increases wouldn’t be warranted until 2023.

It is the latest sign of how an acceleration and broadening of inflationary pressures, together with signs of an ever-tighter labor market, is reshaping officials’ economic outlook and policy planning.

Officials in their postmeeting statement described their goal of inflation moderately exceeding their 2% target as being met and said they would keep rates near zero until they were satisfied labor market conditions were consistent with maximum employment.

They chose to accelerate their stimulus wind down “in light of inflation developments and the further improvement in the labor market,” the statement said.

Fed officials in early November agreed to reduce their then-$120-billion-a-month in bond purchases by $15 billion a month, to $90 billion this month. On Wednesday, officials said they would accelerate that wind down beginning next month, reducing purchases by $30 billion a month. As a result, they will purchase $60 billion in Treasury and mortgage securities in January, putting the program on track to end by March.

The Fed wants to end the asset purchases, a form of economic stimulus, before it lifts its short-term benchmark rate from zero to prevent inflation from staying too high.

Brisk demand for goods, disrupted supply chains, temporary shortages and a rebound in travel have pushed 12-month inflation to its highest readings in decades. Core consumer prices, which exclude volatile food and energy categories, were up 4.1% in October from a year earlier, according to the Fed’s preferred gauge.

Fed Chairman Jerome Powell said two weeks ago the central bank needed to shift its focus toward preventing higher inflation from becoming entrenched and away from fostering a rapid rebound in hiring.

“Almost all forecasters do expect that inflation will be coming down meaningfully in the second half of next year,” Mr. Powell said Dec. 1. “But we can’t act as though we’re sure of that. We’re not at all sure of that.”

Officials last year set out two tests for the economy to meet before they would raise interest rates. First, officials said they wanted to be sure inflation wouldn’t drop below 2%, a goal that for the first time Wednesday they said had been met. Second, they want labor-market conditions to be consistent with maximum employment, a level that isn’t defined numerically.

But if it looks like high inflation is broadening, they might decide instead that they need to raise rates sooner, before meeting the employment goal. 

Officials now expect the unemployment rate to fall to 3.5% next year, below their long-run estimate of 4%. They now see core inflation ending this year at 4.4%, up from a projection of 3.7% in September, before falling to 2.7% at the end of 2022, versus a projection of 2.3% in September.

The projections show all 18 participants expect rates will need to rise next year. After projecting three quarter-percentage-point rate rises next year, most officials penciled in at least three more rate increases in 2023 and two more in 2024. That would leave short-term interest rates slightly below what is known as the neutral level designed to neither spur nor slow growth.

Beginning in April, officials characterized elevated inflation as “transitory,” largely because it reflected supply-chain bottlenecks that officials expect will abate. But they stopped using that term in their policy statement Wednesday, partly due to confusion over what the word means and partly to reflect greater uncertainty over how long it could take inflation to slow.

Officials have been surprised in recent months by a run of hotter economic data that hints at stronger demand in the U.S. economy and not simply idiosyncratic supply constraints that have also pushed up prices. A sharp run-up in home values, stocks and other assets has boosted wealth for many Americans, fueling stronger demand and potentially allowing some to retire earlier than they had anticipated, tightening the labor market.

Questions remain over the tightness in the job market, especially because it is hard to tell how many people might have left the workforce for good. Over the three months ending in November, the unemployment rate fell by 1 percentage point, to 4.2%.

“We are making rapid progress towards maximum employment,” Mr. Powell said at a news conference on Wednesday.

While there are still 3.9 million fewer people working than in February 2020, some of that gap might reflect retirees or others who are choosing not to work for several reasons, including fear of Covid-19, increased household wealth or lack of child care.

Officials are giving more weight to the prospect that the aggressive fiscal- and monetary-policy responses to the pandemic last year altered traditional recessionary dynamics, buoying hiring and wage growth that normally takes longer to recover after a downturn.

A strong employment recovery has led to a sharp pickup in demand for housing, sending rents higher and raising the prospect that even if recent sharp price increases for used cars and imported goods reverse, underlying inflation might be firmer than the Fed previously anticipated.

At the same time, officials are unsure about what the more transmissible Omicron variant of the coronavirus will do to consumer spending, workforce participation and global supply chains in the coming weeks.

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