Some Fed officials have begun to acknowledge that they were too slow to respond to rapid inflation last year, a lag that is forcing them to tighten the economy more sharply now, and one that could hold lessons for the political path ahead. follow, continue.
Inflation started to accelerate last spring, but Fed policymakers and most private-sector forecasters initially thought price gains would fade quickly. By early fall it became clear that rapid inflation was proving more durable, but the Fed pivoted to a rapid removal of policy support only 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 Fed’s approach to setting the policy slowed it down.
Officials had spent years dealing with lukewarm inflation, leaving some hesitant to believe rapidly rising prices would last. Even as they grew more concerned, it took time for the Fed’s large group of policymakers to come to an agreement on how to respond. Another complicating factor was that the Fed had made clear promises to markets on how it would remove support for the economy, which made it difficult to tighten quickly.
“It was a tricky situation with little precedent: People make mistakes,” Randal K. Quarles, who was the Fed’s vice chairman of supervision in 2021, said at a conference last week.
Quarles, who left the Fed at the end of the year, argued that he should have started aggressively withdrawing support after September. He added, however, that the rate hikes central bankers are now making could still fix the situation.
Still, the delay could have consequences. When the Fed stopped buying bonds altogether and began raising rates in March, prices were up 8.5 percent from a year earlier, the highest rate since 1981. Consumer price increases are expected to continue. being quick when new data is released on Wednesday.
Understand inflation and how it affects you
And as prices have remained high, inflation expectations have been rising, threatening to change the behavior of households and businesses in ways that perpetuate the problem.
With inflation killing paychecks and making it harder for families to buy groceries and cars, it has become a major political issue for President Biden, whose approval ratings have fallen due to concerns about his handling of the economy. During remarks at the White House on Tuesday, Biden called inflation his “top priority” and said his administration was taking steps to contain it. He also tried to push back against Republicans, who have spent months blaming him for stoking inflation, saying his policies were “extreme” and would hurt working families.
“I want all Americans to know that I am taking inflation very seriously,” Biden said, noting that the Fed has the “leading role” in trying to control price increases.
The Fed is now raising rates rapidly to get the situation back under control. Officials raised borrowing costs by half a percentage point this month, their biggest increase since 2000, while announcing two more big adjustments could be coming. They will also start reducing their balance of $9 trillion bond holdings next month.
If the Fed continues to rapidly tighten policy this year as it tries to catch up, policymakers risk putting the brakes on a fast-paced economy. Such sudden stops can do damage, raising unemployment and possibly signaling a recession. Officials typically prefer to apply the brakes on their policies gradually, increasing the chances that the economy will slow down painlessly.
Still, several Fed officials noted that it was easier to say what the Fed should have done in 2021 after the fact: that at the time, it was hard to tell whether price increases would last. Initially, inflation came mainly from a few large products that were in short supply amid supply chain tangles, such as semiconductors and automobiles. Only later in the year did it become clear that price pressures were spilling over into food, rent and other areas.
“I try to be a little funny and say: in a very uncertain time, with an unprecedented environment, without real models to guide us, people will do the best they can,” Raphael Bostic, chairman of the Federal Reserve. Bank of Atlanta said in an interview Monday. Bostic was one of the first voices to suggest that the Fed should stop buying bonds and consider raising interest rates.
Officials have said it was the acceleration in inflation data in September, followed by rising labor costs, that convinced them the price gains could last and that the central bank needed to act decisively. Fed Chairman Jerome H. Powell pivoted on policy in late November as those data points added up.
While Quarles argued that the Fed should have responded when the September data came in, he suggested there was a complicating factor: Powell was waiting to see if he would be reappointed by the Biden administration, which did not announce its decision. decision to reappoint him until mid-November.
Quarles, in an episode of the “Banking With Interest” podcast last week, said reacting to the data was “hard to do until there was clarity on what the Fed’s leadership was going to be going forward.”
What is inflation? Inflation is a loss of purchasing power over time, which means your dollar won’t go as far tomorrow as it did today. It is usually expressed as the annual change in the prices of everyday goods and services, such as food, furniture, clothing, transportation, and toys.
In addition, the Fed had promised to withdraw policy in a certain way, which prevented a quick reorientation once officials began to worry that inflation could last. Policymakers had pledged to keep interest rates at a minimum and continue to buy large sums of bonds until the job market has substantially recovered. They had also clearly laid out how they would remove support when the time came: bond purchases would first slow, then stop, and only then would they raise rates.
The goal was to convince investors that the Fed wouldn’t stop helping the economy too soon and prevent markets from roiling, but that so-called forward guidance meant withdrawing support was a drawn-out process.
“Forward guidance, like everything else in economics, has benefits and costs,” Richard H. Clarida, who was Fed vice chairman in 2021 and recently left the central bank, told a conference last week. “If there is a guideline that the committee feels compelled to follow,” he added, it may be difficult for the Fed to move through a sequence of policy moves.
Fed Governor Christopher Waller noted that the central bank was not sitting still. Markets have started to tighten as the Federal Reserve accelerated its plans to remove policy support through the fall, which is making money to borrow more expensive and beginning to slow economic conditions. Mortgage rates, a window into how Federal Reserve policy is affecting the economy, began rising sharply in January 2021 and are now at their highest level since the 2008 housing crisis.
Mr. Waller also noted that it was difficult to get the Fed’s large policy-setting committee to agree quickly.
“The policy is set by a large committee of up to 12 voting members and a total of 19 participants in our discussions,” he said during 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 “looked at the same data through different lenses, and that’s 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 policy: Officials have said they want to quickly raise rates to the point where they start weighing on the economy, and then go from there. While Powell said the Fed was eyeing half-point hikes at its next two meetings, he gave no clear guidance on what would happen next.
“It is a very difficult environment to try to give a guide to the future, 60 or 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 space 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, said Bostic of Atlanta.
“I felt honored, punished, whatever, to think that I know the variety of possible things that can happen in the future,” he said. “I’ve really tried to stop leaning into one type of story or path.”