WASHINGTON (AP) — Federal Reserve Chair Jerome Powell gambled last year that his ultra-low rate policies would help revive an economy that had sunk deep into a pandemic-induced recession. He has been mostly successful in his gamble.
Yet Powell’s challenge is hardly over. Inflation has jumped to a three-decade high, and Powell’s efforts to contain it will constitute the stiffest test of his next term. Powell will need to face additional challenges, such as the unexpected nature of pandemic recovery or the danger of outpacing other central banks in the world.
Getting inflation under control will be particularly difficult because the Fed isn’t facing a traditionally overheating economy. Normally, the Fed is able to cool off runaway inflation and reduce the danger of high inflation by raising the benchmark interest rate. This will affect other loan rates across the economy. This tends to reduce borrowing and increase spending.
This time, huge government stimulus spending, the release of pent-up demand as the economy reopened and the Fed’s own policies — it’s kept its short-term rate near zero since March 2020 — has supercharged consumer demand. Most of the spending has been channelled into products like furniture, cars and electronics. This surge in demand has caused congestion on ports and railroads, and also created shortages of labor. That combination of factors isn’t something the Fed can fix.
“This isn’t your garden-variety inflation spike,” said Sarah Binder, a political scientist at George Washington University who has studied the Fed. “This pandemic economy is different. There’s really no playbook for: How do you get the soft landing the Fed is always aiming for?”
The economy has 4 million less jobs now than before the pandemic. The Fed has reaffirmed its commitment to maximum employment in a revised policy framework it adopted last year. If the Fed does not correctly calculate and holds rates too low too long in an effort to encourage more job growth, prices could rise rapidly. In order to lower inflation, the central banking would have to raise rates even more. The central bank would have to increase rates again in order to prevent another recession.
“2022, without question, is going to be one of the hardest years that the Fed has had to navigate,” said Claudia Sahm, a senior fellow at the Jain Family Institute and former Federal Reserve economist. “They have a very complicated task ahead of them.”
By most measures, the economy has fared quite well this year, even though high prices have undercut Americans’ confidence in it and made it harder for many households to afford food, fuel and other necessities. On Monday, while introducing Powell and his nominee for vice chair — Lael Brainard, a member of the Fed’s Board of Governors — Biden declared that the U.S. economy has “gone from an economy that was shut down to an economy that’s leading the world in economic growth.” He credited his own policies and the Fed’s as well.
“Things are getting better for American workers,” the president said. “Higher wages, better benefits, more flexible schedules. … Savings are up, home equity is up.”
Consumer prices reached 6.2% during the 12-months ending in October. It was the highest year-over–year increase since 1990. Powell, after having previously describing high inflation as merely “transitory,” now acknowledges that it could persist well into next year.
Many analysts believe that the Fed will increase rates at least twice in 2022, in order to reduce inflation. The Fed plans to maintain an average of 2% per year over the course of time. However, these rate increases are likely to present challenges. Under the new framework devised by Powell and Brainard among others, the Fed wants maximum employment that is “broad and inclusive.” That means it will take account of other data points, like the unemployment rate for Black Americans, rather than just the overall jobless rate.
Yet even if the overall jobless rate falls below 4% next year — it’s 4.6% now — which would be close to what many Fed officials regard as full employment, African-American joblessness would likely be much higher, given the perennial racial gap in unemployment. Black unemployment stands at 7.9%.
Stephanie Aaronson is a former Fed economist and now heads economic studies at Brookings Institution. She noted that the Fed often stated it wanted to maintain a strong economy in order to assist disadvantaged workers to regain their jobs or get higher wages. The central bank could increase rates to curb inflation and prevent potential job gains.
If that should happen, Aaronson said, “they’re going to have to say why they didn’t wait longer.”
She said that Fed officials could also note the fact that higher inflation can be detrimental to lower-income workers.
“They can articulate this, but they’ve got to get started,” Aaronson said.
Joseph Stiglitz (an economist at Columbia University who was also a Nobel Prize winner in economics) suggested that Fed must consider global implications of its policy. For example, the European Central Bank has stated that higher inflation is a temporary phenomenon. It is possible that Powell will raise rates earlier than the ECB, particularly if he does this in the first quarter of next year.
“That will lead to an increase in the (dollar) exchange rate that will decrease our exports, that will lower American competitiveness and that will weaken our economy,” warned Stiglitz, who favored Brainard for Fed chair.
This report was contributed by Paul Wiseman, an AP Economics writer.