Taking Aim at Inflation, Fed Prepares to Hike Interest Rates

WASHINGTON (Los Angeles Times/TNS) -
inflation rate
Chair Jerome Powell and the Federal Reserve are abandoning a wait-and-see strategy and indicated Wednesday that it may be time to begin stepping on the economic brakes. (Mark Makela/Getty ImagesTNS)

With inflation now running at its fastest pace in nearly 40 years and showing no signs of slowing down, the Federal Reserve on Wednesday abandoned its wait-and-see strategy and indicated that it could begin stepping on the economic brakes soon.

Specifically, the central bank signaled it could start raising interest rates as early as next spring as it announced a speedier shutdown of a bond-buying stimulus program that it had implemented to counteract the economic damage from the COVID-19 pandemic. Most Fed officials now see at least three rate hikes in 2022.

Wednesday’s announcement, following the Fed’s last scheduled policy meeting of the year, marked a big pivot for Fed Chair Jerome H. Powell. He and his colleagues had put more emphasis on maximizing employment, and less on the central bank’s other mandate, price stability, as they sought to achieve broad-based economic and job growth. Now the weight has shifted.

As recently as a few months ago, Fed officials saw rising prices as a temporary consequence of supply-chain disruptions and other problems stemming from the pandemic. At that time, Fed policymakers seemed so confident that inflation would fade of its own accord that they mostly predicted interest rates would remain at historic lows until at least 2023.

Now, the sharp shift may be welcomed by economists and others who doubted the Fed’s optimistic assessment, but it also adds a new element of uncertainty to a U.S. and global economy already uneasy about the future.

“My concern is that we’re going to go from a patient to a panic Fed on inflation,” said Diane Swonk, chief economist at the accounting firm Grant Thornton and a longtime Fed watcher.

Forced to make critical policy decisions with far less than total information, the Fed is caught in a dilemma: If it does too little to combat inflation, that could feed widespread expectations that prices will continue to soar for months and years to come.

More workers, for example, might begin pushing harder for big pay increases, which would raise employers’ costs. And businesses could begin raising prices to keep ahead of the curve.

On the other hand, if the Fed applies the brakes too hard, it could stifle the nascent economic recovery and push the country toward recession.

Adding to the uncertainty, while the overall economic growth looks strong, the total number of jobs in the U.S. remains almost 4 million short of what it was before COVID-19 struck.

And the fog over COVID variants and their effect on consumers and businesses add to the difficulty of forecasting exactly what the impact might be of different policy choices open to the Fed.

Unlike past pandemics and wartime shocks, Swonk noted, technology kept the economy moving, with much more remote work and online purchases. But a surge in demand for goods has exacerbated production and supply problems, including shortages of semiconductors and raw materials, as well as labor.

At the same time, consumer spending and prices of stocks and houses have been juiced by trillions of dollars of fiscal pandemic aid and extraordinary monetary support from the Fed, including massive purchases of Treasury and mortgage securities.

A bunch of other factors have added fuel to the fire: Companies have seized the chance to make up revenue they lost during lockdowns, raising prices in many cases. Workers have seized on the chance to demand more money and better working conditions. Politicians have seized on the chance to turn the country’s problems into opportunities for themselves and their favored groups.

“It’s really a tightrope act, and the risk of a misstep by the Fed goes up because there are so many things happening at once,” Swonk said.

About two weeks ago, Powell said it was time to drop the word “transitory” in describing the run-up in inflation, a view that policymakers, including officials in the Biden administration, had espoused for months but could no longer support after persistent price increases.

What hasn’t changed in Powell’s thinking is that policy will be dictated largely by the course of the pandemic. And that may be the biggest reason inflation is turning into a much bigger problem — politically, if not entirely economically — than many economists figured. The pandemic simply has not turned out the way most experts expected.

Instead of a terrible episode in which a lot of people got sick and many died but then things got better, COVID has turned out to be a rolling catastrophe that never seems to end. And that’s been reflected in the fits and starts of this recovery.

After relatively sluggish growth in the third quarter, in part due to the Delta variant, the economy is expected to finish the year with a flurry of activity behind strong spending by consumers.

Richard Curtin, director of the University of Michigan’s monthly consumer sentiment surveys, said that people who have been isolated for so long now want to enjoy the holidays with families and purchase nice gifts.

It’s what happens early next year that worries Curtin. He expects households to pull back. The omicron variant may figure into that, but it’s also because of the recent rise in prices, he said.

Inflation has been increasing notably since early this year, reaching a 6.8% annualized rate in November compared with the same month in 2020.

The broad-based increase in prices, including food, gas, housing, apparel and cars, has become a political challenge for President Joe Biden. And there’s not a whole lot the president can do about it, although he has sought to loosen shipping and supply bottlenecks, especially at Los Angeles-area ports.

He has also tapped the nation’s petroleum reserve in a bid to lower fuel prices.

Biden tried to get out in front of the last inflation numbers, saying that pump prices have come down in recent days. And some economists see the supply chain mess showing signs of easing.

Still, expenses for things like shelter, which accounts for 40% of the government’s core consumer price index, may increase even more. And labor shortages, which already have pushed up wages, particularly for lower-earning workers, may keep putting upward pressure on overall prices.