The Fed Needs to Recognize the Recovery
(Bloomberg Opinion) -- Presenting the Federal Reserve’s semiannual report to Congress, Chair Jerome Powell didn’t budge. The current surge in inflation is temporary, he said, and the central bank won’t rein in its hyper-accommodative monetary policy until the economy has made “substantial further progress.” Powell and his colleagues may prove to be right that higher inflation is just a blip — the course of the economy is very hard to predict right now. Yet, given those very uncertainties, the Fed’s message to financial markets has come to seem too rigid.
There are things both Powell and President Joe Biden could do to help put this right.
The central bank committed itself to its current approach last year, when the case for maximum monetary stimulus was indisputable. Since then, the U.S. economy has recovered more strongly than expected, fiscal policy has delivered much more stimulus than expected, and inflation has risen faster than expected. Yet the Fed isn’t deviating. It’s still promising to hold short-term interest rates at zero indefinitely, and continues to expand its balance sheet by buying $120 billion a month in government bonds and mortgage-backed securities. None of this will change, it says, without that now-totemic “substantial further progress.”
Yet what this means is anything but clear. The central bank says it wants to see inflation running moderately above its 2% target, to make up for shortfalls in earlier years. That’s fine — but how much above, and for how long? It hasn’t said. The other part of its reinterpreted mandate is to achieve “maximum employment.” This new coinage is ambiguous, too. For the moment, the Fed prefers not to talk about “full employment,” the point beyond which wage and price inflation are supposed to become a serious threat (presumably because earlier estimates of what it might be would argue for greater caution). But it hasn’t adequately explained the difference.
The Fed’s calculations are undeniably difficult. The current inflation numbers are badly distorted by so-called base effects (because inflation dropped so sharply as the pandemic and the shutdowns hit). And inflationary pressures appear to be spreading only slowly beyond the worst–affected sectors. A good part of the surge in inflation will indeed prove temporary, just as the Fed says.
Moreover, the central bank’s professional competence isn’t in doubt. Long-term bond yields have stayed low despite higher-than-expected growth and inflation — and the Fed’s bond buying can’t explain this all by itself. Persistently low long-term yields suggest investors trust the Fed to stop things from getting out of hand. In a sense, they think the Fed is more attentive to data and faster on its feet than many of the central bank’s own statements suggest.
Even so, there’s a danger that this confidence could end, and perhaps abruptly. That’s why Powell would be wise to make clear that he and his colleagues are watching the economy with an open mind. The best way to do this would be to promptly begin tapering purchases of mortgage-backed securities. That would ease emerging fears of a house-price bubble, and it would tell investors that the Fed can recognize a strong recovery when it sees one.
In a smaller way, the White House could help, too. Powell’s term as chair ends in February. It’s important that investors don’t ask whether his hopes of reappointment are influencing his judgment. The president could and should deal with this right away by announcing that if Powell wants another term, he’ll get one.
Reading the economy has never been harder than now, and maintaining investors’ confidence in the central bank never more important. In watching and responding to the data, Powell’s Fed must be — and must be seen to be — sufficiently flexible and genuinely open-minded.
Editorials are written by the Bloomberg Opinion editorial board.
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