On Wednesday, the Federal Reserve Open Market Committee (FOMC) met again to discuss the state of the macroeconomy and how to proceed with monetary policy in the face of the continued pandemic. As expected, the FOMC stood pat, announcing that it would keep the federal funds rate between zero and a quarter of a percent while continuing to increasing its Treasury and mortgage-backed securities holdings by at least $80 and $40 billion respectively. The committee, in familiar language, also reaffirmed that that the central bank will remain “committed to using its full range of tools to support the U.S. economy in this challenge time, thereby promoting its maximum employment and price stability goals.” During the press conference, Federal Reserve Chairman Jay Powell also reiterated that the economic recovery would continue to depend on the course of the COVID-19 virus, adding that vaccination efforts remain an important factor as the economy continues to reopen.
In addition to this steadfast messaging from the FOMC, Powell also gave some important labor market updates, as he announced that the economy added an additional 916,000 jobs in March, with the hospitality and leisure sectors making sizable gains. However, despite this uplifting news, the chairman was quick to point out that the unemployment rate remains at an elevated level of 6 percent as of March, and payroll jobs overall are still a staggering 8.4 million less than pre-pandemic levels. Despite this, household spending on goods and services has continued to rise, and with one Congressional stimulus effort in the books and a potential infrastructure bill on the way, many have begun to worry about the possibility of rapid inflation. The FOMC addressed this concern in its statement, mostly sticking to the same language used since August 2020, saying that it will “seek to achieve maximum employment and inflation at the rate of 2 percent over the long run.” In accordance with their average inflation target adopted last August, the FOMC also noted its goal to “achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time, and longer-term inflation expectations remain well anchored at 2 percent.”
However, because of base effects stemming from the Fed’s inflation calculations last year, Powell also noted that 12-month measures of the inflation rate have begun to register above 2 percent in the past month. This prompted a number of questions from reporters regarding inflation worries and potential Fed plans to wind down asset purchases in conjunction with interest rate hikes. In response, Powell was quick to not only downplay any inflationary fears, but he also provided strong and clear forward guidance regarding any Fed plans to commit to asset tapering or rate hikes. Concerning the fears of rising inflation, the chairman offered two explanations as to why we may see higher prices in the future, while noting any increase would be temporary in nature.
First, Powell clarified that any jump in the inflation rate is strictly transitory; specifically meaning that any rise in the price level will simply be due to the effects of a reopening economy. Secondly, Powell pointed to increased supply bottlenecks around the globe. Because of the broad economic impacts of the pandemic, numerous industries are experiencing temporary restrictions in their supply chains, resulting in a delay in some goods arriving to the US. This supply chain slowdown, Powell explained, will show up in the form of higher prices. Additionally, he noted that although these bottleneck effects are temporary, there is no known timetable for when they will subside. Put differently, although inflation will likely surpass 2 percent this year and possibly be more than 2 percent even after this year, the Fed believes it’s unlikely that inflation will significantly or persistently exceed that target beyond this year.
Outside of these explanations, the chairman was quick to offer continued and clear forward guidance on how the Fed will address inflation concerns moving forward. In an exasperated tone, Powell noted that the central bank will alert the public to any potential interest rate hikes well before they are set to take effect. Additionally, he expressed in very certain terms that the economy is still not near its full capacity, as there are still massive labor market shortfalls and businesses still struggling to deal with the effects of the pandemic. Although the economic scarring likely will not be quite as bad as the Fed initially feared, Powell made it clear that as long as there is slack in the labor market, the central bank will continue to keep monetary policy accommodative. In fact, he noted that the Fed will welcome an inflation rate above 2 percent in order to achieve the Fed’s stated 2 percent average inflation target, given that the Fed had regularly undershot its 2 percent inflation target over the last decade.
Overall, the FOMC’s messaging has remained largely the same throughout the past several months. With summer approaching and vaccinations becoming widely available to every American across the country, the prospects for the economic recovery look increasingly better with each passing day. As such, the Fed is sticking to its guns and keeping monetary policy accommodative enough to ensure that the flow of credit to U.S. households and businesses remains uninterrupted. Despite concerns about rising inflation in the near future, Powell sent a resounding message to markets: don’t fret, everything is going according to plan. Whether inflation fears are overblown remains to be seen, but from the central bank’s point of view, its forward guidance suggests the economy and its recovery is as strong as ever.