The Fed Should Say It’s Ready to Rethink
(Bloomberg Opinion) -- The Federal Reserve had little choice last year but to promise pedal-to-the-metal monetary accommodation for the foreseeable future. This unequivocal commitment was the only instrument it had left to provide what was then a necessary stimulus. Now, awkward as it might be — not least for its own credibility with investors — the Fed needs to start walking this promise back.
Today’s monetary-policy settings aren’t necessarily wrong. Interest rates close to zero and hefty monthly bond purchases might very well be the correct posture for the Fed right now. Yet new economic data has underlined the risks in the outlook. The Fed needs to show it’s watching these uncertainties with an open mind, rather than telling markets, as it has of late, “Nothing to see here, move along.”
Consumer prices in April were 4.2% higher than a year earlier. To be sure, this number is distorted. Prices dropped sharply in the spring of 2020, giving the latest year-over-year number a temporary boost. And April saw exceptionally big increases in some narrow components of the index. (In particular, the price of used cars soared, partly because the global chip shortage has throttled manufacturing of new vehicles.) So-called core inflation, which excludes some volatile components, increased by less than prices overall — 3% over April 2020. Yet these and other factors were known in advance, and the figures were still higher than expected.
In response, Fed officials simply restated the central bank’s earlier position: Interest rates will be held at zero until core inflation is averaging 2% and full employment has been restored. Fed Vice Chairman Richard Clarida said accelerating prices will have “only transitory effects on underlying inflation.”
The second data surprise was bigger. Payrolls grew by 266,000 from March. Economists surveyed by Bloomberg had expected a hiring surge of 1 million. On the face of it, slow hiring, combined with an employment shortfall of more than 8 million jobs compared with before the pandemic, suggests a slack labor market and faltering recovery, implying that the Fed is right to keep monetary policy as loose as possible.
But other indicators say different. Wages are rising at a healthy clip. Vacancies are high and many employers, according to the Fed’s own survey of business sentiment, are reporting labor shortages and difficulty in hiring. These are signs of a labor market that’s tight, not loose.
If the slow pace of hiring is due, in part, to the extended unemployment benefits provided in the most recent pandemic-relief package, hiring will pick up as those benefits expire later this year, and employment will recover without dangerous upward pressure on costs. But if it’s due to a post-pandemic mismatch between the workers who’re available and the workers companies need — that is, to a lasting structural change — then the labor market is tighter than April’s hiring number suggests and total employment is a misleading metric. In that case, further demand from loose monetary policy risks adding to upward pressure on wages and prices.
As with the inflation numbers, the picture is uncertain — and, as with the inflation numbers, Fed officials are mostly sticking to their line. Clarida said that April’s jobs report left the Fed no closer to tapering its bond purchases than before. Minneapolis Fed President Neel Kashkari said the figures were a sign that “We have a long way to go, and let’s not prematurely declare victory.”
On Wednesday, as minutes of the central bank’s policy meeting at the end of April were released, St. Louis Fed President James Bullard and Atlanta Fed President Raphael Bostic talked of the need to monitor developments and adjust policy when necessary. But the minutes themselves were almost comical in their refusal to shed further light: “A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases” [emphases added].
Former Treasury Secretary Larry Summers has accused the Fed of encouraging “dangerous complacency” in financial markets. With asset prices pushed to outlandish levels, this danger is real. Reluctance to acknowledge conflicting signals about the prospects for employment, wages and prices is unwise. The longer it goes on, the greater the danger that an eventual, unavoidable course correction for monetary policy will shock the economy with brutal consequences.
Nobody should doubt that the Fed is watching the numbers carefully — more anxiously than it’s letting on, in all likelihood. And having promised prolonged monetary stimulus, it shouldn’t change course lightly. If it did, its next such promise would be discounted accordingly. Despite all this, the Fed needs investors to understand that it’s willing to rethink its position as and when the numbers demand. At the moment, that message isn’t getting through.
Editorials are written by the Bloomberg Opinion editorial board.
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