Officials indicate inflation may stay longer
Federal Reserve officials expect supply-chain bottlenecks and labor shortages will continue to hamper the economy and drive up inflation for longer than previously expected, with the omicron variant posing further economic uncertainty, according to minutes released Wednesday from the Fed’s December policy meeting.
When Fed leaders convened in mid-December, they made their strongest move yet to tackle inflation, moving up the timeline for what could be as many as three interest rate hikes next year. The Fed’s policy pivot toward inflation, and away from boosting the job market, marked a significant shift in how the Fed plans to respond to rising costs during the coronavirus pandemic.
Fed leaders also sped up the pace at which it is drawing down its vast asset purchase program so it can be better prepared to raise interest rates as early as this spring.
Minutes from the December Fed meeting offered a deeper look into what shaped policymakers thinking as the brutal surge of the omicron variant was just underway.
Fed policymakers generally expected global supply chain bottlenecks to persist for some time, with a few officials saying some businesses were up against “deteriorating” supply constraints that could be made worse by new variants of the virus.
Looking ahead, officials pointed to the rising cost of housing and rent, wage growth driven by worker shortages, and prolonged supply-chain issues. They also discussed how such high inflation measures could start to change peoples’ expectations for what prices will be like in the future. That’s dangerous territory for the Fed, since inflation dynamics can be somewhat self-fulfilling if people change their behavior now to get ahead of perceived price hikes down the road.
“Participants noted their continuing attention to the public’s concern about the sizable increase in the cost of living that had taken place this year, and the associated burden on U.S. households, particularly those who had limited scope to pay higher prices for essential goods and services,” the minutes read.
The Fed’s main tool for combating inflation is through interest rates, which it can raise or lower depending on what is happening in the economy. The Fed slashed rates to zero at the beginning of the pandemic to give households and the economy as much support as possible. And since spring of 2020, the Fed has been hesitant to raise rates until the labor market has fully healed. (Higher interest rates tend to slow growth in the labor market.)
But that approach has come under intense pressures as inflation soars to nearly 40-year highs and the labor market, while still vulnerable to the ongoing pandemic, has made major strides. With Fed leaders forecasting three rate hikes in the coming year, policymakers will have to judge when the labor market has reached “full employment,” or if the Fed will have to step in sooner to get control of inflation.
According to the minutes, some policymakers said there could be situations when the Fed would raise rates before full employment was reached, including if inflation pressures and inflation expectations were moving materially and persistently higher.