Fed Worried About Inflation Risk as It Firmed Up Tapering Plan

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Some central bankers at their meeting last month proposed raising interest rates later in 2022 amid risks of more persistent inflation

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Under the plans discussed last month, the Fed will reduce its purchases by $15 billion per month, split proportionally between Treasury and mortgage bonds. Officials discussed starting the taper in mid-November; If they follow the schedule set last month, the purchase will end in July.

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The program to phase out the Fed’s stimulus program is somewhat faster than investors expected a few months ago. This partly reflects that this year’s rise in inflation has been longer than expected by central bank officials and private sector economists.

Officials do not want to be in a position where they feel compelled to raise rates at a time when they are still promoting monetary incentives by buying assets.

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Minutes said many participants at last month’s meeting preferred to reduce purchases even faster. Those officials are eager to end their asset purchases to gain the flexibility to raise rates next year if needed, as they think inflation could run above the Fed’s 2% target.

The Fed lowered its short-term benchmark rate to near zero in March 2020 as the coronavirus pandemic hit the US economy.

Officials debated last month when the Fed might need to lift rates to near zero. The minutes said an unspecified number of officials raised the prospect of a start raising rates by the end of next year as they expected labor markets and inflation to meet targets set by the Fed a year ago. Some of these officials thought that inflation would remain high until next year.

Another group thought the economy could guarantee remaining rates at or near their current setting over the next two years as they expected inflationary pressures to reverse next year. These officials said raising rates too soon and too quickly could undermine the Fed’s recent commitments to keep inflation flowing below its 2% target.

new estimates released Half of the 18 officials who attended at the end of last month’s meeting expected the economy to need an interest rate hike by the end of 2022.

Rising vaccination rates and nearly $2.8 trillion in federal spending approved since December have not produced any recovery in recent memory. Inflation has soared this year, with so-called core prices, which using the Fed’s preferred gauge, pushed volatile food and energy categories to 3.6% in August from a year ago. The gains largely reflect disrupted supply chains and labor and material shortages.

A separate index of core inflation rose 4% in September from a year earlier, the Labor Department reported Wednesday, matching the year-over-year increase recorded in August. According to the Labor Department, overall consumer inflation has risen at the fastest pace in 13 years since May.

Fed staff forecasts prepared last month revised their inflation forecasts, but bank economists still expect this year’s rise in inflation to prove tentative, the minutes said. “Employees interpreted recent inflation data to indicate that supply constraints were putting more pressure on prices than previously thought,” Minutes said. “It was also expected to take longer to resolve these supply constraints,” compared to the previous launch made in late July.

The minutes also indicated that employee economists pointed to a risk that future inflation expectations of households and businesses will “go significantly higher”, a dangerous development for central bank officials as they believe that inflation expectations will increase significantly. That such inflationary expectations play an important role. effecting real inflation.

Fed Chairman Jerome Powell frequently approaches his job to adjust the central bank’s policy stance to manage risks of weaker than expected growth or stronger than expected growth. This means the Fed may change its setting not only because the economy weakens or strengthens, but also because the risks surrounding the outlook change.

During a general discussion on September 29, Mr. Powell acknowledged that the Fed is facing a situation it hasn’t faced in a very long time, with the central bank’s low, stable inflation as well as two highs of high. There is tension between the objectives. employment. “Managing through that process over the next few years… is going to be very challenging because we have this hypothesis that inflation will be transient. We think that is correct,” he said. Concerned about expectations remaining stable, as they have been so far.”

At last month’s meeting, officials cited risks that high inflation could last longer than anticipated, that additional spending by Congress and the White House could further spur demand and that consumer spending on large savings accumulated during the pandemic. Can be picked up in between minutes. .

“Inflation numbers have been poor, and supply chain information is very poor. It looks less fleeting and some of these supply chain difficulties will remain for a while,” said William English, a former senior Fed economist who now Professor at Yale School of Management. That means high inflation could last longer than some Fed officials expected.

“The important question is, when does this start to undermine public sentiment that inflation will come back to 2%?” said Mr. English. “Inflation risks now look bigger than they did a few months ago.”

Nick Timiros and nick.timiros[email protected]

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