Pandemic tests Federal Reserve's new policy plan

When Jerome H. Powell speaks at the Federal Reserve’s largest annual conference on Friday, he will do so at a tense economic time, as pr...

When Jerome H. Powell speaks at the Federal Reserve’s largest annual conference on Friday, he will do so at a tense economic time, as prices rise rapidly as millions of jobs remain absent from the labor market. This combination promises to test the meaning of a quiet revolution the presidency of the central bank inaugurated a year ago.

Mr Powell used his remarks at last year’s conference, known as the Jackson Hole Economic Symposium and hosted by the Federal Reserve Bank of Kansas City, announce that Fed officials would no longer raise interest rates to calm the economy simply because unemployment was falling and inflation had to rise. First they wanted proof that prices were rising in a sustainable way, and they would welcome gains slightly above their 2% target.

He laid the groundwork for a much more patient approach by the Fed, recognizing the grim reality that in advanced economies, interest rates, growth, and inflation had spent the 21st century on a downward spiral undermining strength. The goal was to stop the decline.

But a year later, that backdrop has changed, at least superficially. Heavy government spending in response to the pandemic has pushed consumption and growth up in the United States, and inflation has exploded at levels not seen in over a decade. The labor market is recovering quickly, although it has not yet fully recovered. Now it’s up to Mr. Powell to explain why full Fed support is still needed.

Investors initially expected Mr. Powell to use Friday’s remarks at the Jackson Hole conference to outline the Fed’s plan to “cut” – or slow down – a large bond buying program. scale it uses to support the economy. Fed officials are debating the timing of such a move, which will mark their first step towards a more normal political framework. But after minutes from the July central bank meeting suggested the discussion was far from resolved, and as the Delta variant pushes coronavirus infections higher and threatens the economic outlook, few are now anticipating a clear announcement.

“Two or three months ago, people were expecting the whole reduction plan at Jackson Hole,” said Priya Misra, head of global rates strategy at TD Securities. “Now it’s more the economic outlook that people struggle with. “

Mr Powell’s speech, which will be virtual, could instead give him the opportunity to explain how the Fed views Delta variant risks, recent rapid inflation and labor market progress – and how the three fit into the political approach of the central bank.

The Fed buys $ 120 billion in government guaranteed bonds each month, and it has kept its prime interest rate close to zero since March 2020. Both policies make borrowing cheap, fueling corporate spending and households and strengthening the labor market.

Officials have clearly tied their interest rate plans to their new framework: They said in September that they wouldn’t increase the rates until the labor market reaches full employment. Bond buying is less directly linked, but it serves as a signal of the Fed’s continued patience.

Critics of the Fed’s wait-and-see stance have questioned whether it is wise for the Fed to quickly buy mortgage-backed and Treasury-backed debt when house prices have gone up and inflation took off. Republican lawmakers and some prominent democrats similarly, they were concerned that the Fed is not being agile enough as economic conditions change.

“They chose a framework designed to engage in a very accommodating policy,” said Lawrence H. Summers, secretary of the Treasury in the Clinton administration and economist at Harvard University. “The problem turned into overheating being the big concern, rather than underheating.”

Inflation jumped to 4% in June, based on the Fed’s preferred measure. Most economists expect the rapid price gains to fade as the pandemic bottlenecks subside, but it’s unclear how quickly and to what extent that will happen.

And although there are still nearly seven million fewer jobs than before the pandemic, unfilled positions having jumped, the wages of low wages soar and employers complain widely not be able to hire enough workers. If labor costs remain higher, this could also lead to more lasting inflationary pressures.

Some Fed officials would prefer to slow bond buying soon, and quickly, so that the central bank will be able to raise interest rates next year if price pressures become pernicious.

Other policymakers see the current rise in prices and job vacancies as trends that are bound to subside. Businesses will overcome supply chain disruptions and consumers will spend the savings they have accumulated from government stimulus checks and months spent at home. Workers will move into jobs. When things get back to normal, they reason, the lukewarm inflation of years past is likely to return.

Given this point of view and the fact that the job market still lacks so many positions, they argue that the Fed’s new policy paradigm requires patience.

At the central bank meeting at the end of July, minutes showed, some officials expressed concern that the Fed “should be aware of the risk that a spending cut announcement that was seen as premature could call into question the committee’s commitment to its new monetary policy framework.”

Mr Powell generally tries to balance the two concerns in his public remarks, acknowledging that inflation could stay high and promising that the Fed will respond if it does. But he also pointed out that recent price hikes are more likely to fade, and the central bank would rather stay useful while the labor market heals.

But in the months to come, the Fed will have to make concrete decisions, putting the meaning of its new framework to a very public test. Economists generally expect the central bank to announce a plan to curb its bond purchases in November or December.

Once this reduction is underway, attention will turn to interest rates, most likely with inflation still above 2% and the recovery in the labor market still threatened. When the Fed hikes rates, that will determine how transformative the new policy framework has been.

Since the The Fed’s economic forecast for June, most officials did not expect to increase borrowing costs until 2023. If this happens, it will be a noticeable change from years past, a change that will allow the labor market to heal much more. completely before drastically cutting cash assistance.

In 2015, when the Fed last raised interest rates near zero, the unemployment rate was 5% and 77% of people aged 25 to 54 were working. Already unemployment is 5.4 percent and 78 percent of prime-age adults are working.

In fact, Fed officials projected that rates would remain unchanged even if unemployment fell to 3.8% by the end of next year – below their estimate of the rate consistent with longer-term full employment, which is around 4% .

“This is the most exciting part of what has changed: They are targeting an ambitious pre-pandemic labor market,” said Skanda Amarnath, executive director of Employment America, a group that tries to persuade economic decision-makers to focus on employment. “A fig leaf of progress is not enough. “

But the risks lie in both directions.

If inflation remains high and an overly optimistic Fed has to quickly change course to try to contain it, it could precipitate a painful recession.

But if the Fed unnecessarily withdraws its support, the labor market may take longer to recover, and investors may see the changes Mr. Powell announced last year as a minor adjustment rather than a meaningful commitment to increase. inflation and fostering a more inclusive labor market.

In this case, the economy could fall back into a cycle of long-term stagnation, much like the one that Japan and much of Europe faced.

“This will be an episode that will test the patience and credibility of the Federal Reserve,” said David Wilcox, a former Fed personnel officer who is now director of US economic research at Bloomberg Economics.

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Newsrust - US Top News: Pandemic tests Federal Reserve's new policy plan
Pandemic tests Federal Reserve's new policy plan
Newsrust - US Top News
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