The Fed addresses why it may have acted too slowly on inflation

Some Federal Reserve officials have begun to acknowledge that they have been too slow to respond to last year’s rapid inflation, a delay that is forcing them to constrain the economy more abruptly now and that could hold lessons for the future policy path. .

Inflation began to accelerate last spring, but Fed policymakers and most private sector forecasters initially thought the price gains would fizzle out quickly. It became clear in early autumn that rapid inflation was proving to be more lasting, but the Fed only moved towards rapid removal of political support in late November and did not raise rates until March.

Several current and former Fed officials have suggested in recent days that, in hindsight, the central bank should have reacted more quickly and forcefully last fall, but that both deep uncertainty about the future and the The Fed’s Approach to Policy Making slowed him down.

Officials had spent years dealing with tepid inflation, which made some hesitant to believe the rapidly rising prices would last. Although they became more concerned, the Fed’s large group of politicians took some time to reach agreement on how to respond. Another complicating factor was that the Fed had made clear promises to the markets about how it would remove support for the economy, which made quick adjustment more difficult.

“It was a complicated situation with little precedent: People make mistakes,” Randal K. Quarles, Fed vice president for oversight in 2021, said at a conference last week.

Mr. Quarles, who left the Fed at the end of the year, said he should have started to aggressively withdraw support after September. He added, however, that the rate hikes central bankers were making now could still resolve the situation.

Even so, the delay could have consequences. When the Fed completely stopped buying bonds and started raising rates in March, prices were rising 8.5 percent compared to a year earlier, the fastest rate since 1981. Consumer price increases are expected to remain rapid when new data is released Wednesday.

And as the high prices have grown, inflation expectations I have been creepingthreatening to change family and business behavior in ways that perpetuate the problem.

As inflation is wasting wages and making it harder for families to afford groceries and cars, it has emerged as a major political issue for President Biden, whose approval ratings have fallen due to concerns about his running the economy. . During comments at the White House on Tuesday, Biden called inflation his “top domestic priority” and said his administration was taking steps to contain it. He also tried to fend off Republicans, who spent months accusing him of fueling inflation, saying their political views were “extreme” and would harm working families.

“I want all Americans to know that I am taking inflation very seriously,” Biden said, noting that the Fed has the “primary role” in trying to tame price increases.

The Fed is now rapidly raising rates to bring the situation back under control. Officials raised loan costs by half a percentage point this month biggest increase since 2000, while it broadcasts that two more big adjustments may be on the way. They will also begin reducing their balance sheet by $ 9 trillion in bonds next month.

If the Fed continues to swiftly adjust policy this year as it tries to catch up, policymakers risk putting the brakes on an accelerating economy. Such hard shutdowns can do harm, increase unemployment and possibly trigger a recession. Officials generally prefer to gradually apply the brakes of their policies, increasing the chances that the economy will slow down painlessly.

However, several Fed officials pointed out that it was easier to tell what the Fed should have done in 2021 after the fact – that at the time it was hard to know that the price hikes would last. Inflation initially came mainly from a few large products that were in short supply amid supply chain difficulties, such as semiconductors and automobiles. Only later in the year did it become apparent that price pressures were spreading to food, rents and other areas.

“I try to do a little grace and say: in a very uncertain moment, with an unprecedented setting, with no real role models to guide us, people will do their best”, Raphael Bostic, president of the Federal Reserve Bank of Atlanta, he said in an interview Monday. Mr. Bostic what early entry suggesting that the Fed should stop buying bonds and consider raising interest rates.

Officials said it was the acceleration of inflation data in September, followed by rising labor costs, that convinced them that the price gains could last and that the central bank needed to act decisively. Fed chairman Jerome H. Powell pivoted to politics in late November when those figures added up.

While Mr. Quarles argued that the Fed should have responded when the September data arrived, he suggested that there had been a complicating factor: Mr. Powell was waiting to see if he would be reconfirmed by the Biden administration, which didn’t announce its decision to rename him until mid-November.

Mr. Quarles, on a Episode of the “Banking With Interest” podcast. last week, he said reacting to the data was “difficult to do until there was clarity about what the Fed’s leadership would be in the future.”

Additionally, the Fed had promised to pull back the policy in a certain way, which prevented a quick reorientation once officials began to worry that inflation might last. The politicians had pledged to keep interest rates to a minimum and continue to buy large amounts of bonds until the job market healed substantially. They also clearly explained how to remove support when the time came: bond purchases would first slow down, then stop and only then would rates rise.

The point was to convince investors that the Fed would not stop helping the economy too soon and avoid the markets rally, but that so-called forward guidance meant that withdrawing support was a long process.

“Driving forward, like everything in economics, has benefits and costs,” Richard H. Clarida, a Fed vice president in 2021 and who recently left the central bank, said at a conference last week. “If there is guidance that the committee feels compelled to abide by,” he added, it can be difficult for the Fed to go through a sequence of political moves.

Christopher Waller, a Fed governor, noted that the central bank was not just standing still. Markets began to adjust as the Fed accelerated its plans to remove political support during the fall, which is making money more expensive to borrow and starting to slow economic conditions. mortgage ratesa window into how Fed policy is performing in the economy, it started to rise significantly in January 2021 and is now at its highest level since the 2008 housing crisis.

Mr. Waller also pointed out that it was difficult to get the Fed’s large policy-making committee to agree quickly.

“Policy is defined by a large committee consisting of up to 12 voting members and a total of 19 participants in our discussions,” he said in a speech last week. “This process can lead to more gradual changes in policy as members have to compromise to reach a consensus.”

Loretta Mester, president of the Federal Reserve Bank of Cleveland, said in an interview Tuesday that different people on the committee “have looked at the same data with different objectives, and that’s just the nature of the beast.”

But the Fed appears to be learning lessons from its 2021 experience.

Policymakers are avoiding giving clear guidance on what comes next for the policy: officials have said they want to get rates quickly to the point where they start weighing on the economy, and then move on from there. While Mr. Powell said the Fed was considering a half-point hike in its next two meetings, he didn’t provide clear guidance on what would follow.

“It is a very difficult environment to try to provide forward guidance, 60, 90 days in advance – there are so many things that can happen in the economy and around the world,” Powell said at a news conference last week. “So we’re giving ourselves room to look at the data and make a decision as we get there.”

The war in Ukraine is the latest surprise that is changing the outlook for the economy and inflation in ways that are hard to predict, Atlanta’s Bostic said.

“I’ve been humiliated, chastised – whatever – thinking I know the range of possible things that can happen in the future,” he said. “I really tried to avoid leaning on one type of story or path.”