The Federal Reserve Should Still Start Tapering

(Bloomberg Opinion) -- At the Federal Reserve’s next policy meeting, on Sept. 21–22, officials will resume their debate about when and how to taper their Covid-related bond-buying program. Signs of a slowing economy thanks to the resurgent pandemic have complicated matters — especially when it comes to explaining the policy to investors — but the basic calculation hasn’t changed. Neither the recent setbacks nor Tuesday’s more-moderate-than-expected inflation figures should deflect the Fed from beginning to taper promptly and from planning to end the program by the spring.

The Fed has said it wants to see “substantial” progress on jobs and inflation before dialing back its $120 billion a month of bond purchases. Its medium-term goal for inflation is to slightly exceed (by an unspecified amount and for an unspecified period) the central bank’s long-term 2% target. The benchmark for jobs is “maximum employment.” At its last policy meeting, Fed Chairman Jerome Powell said that inflation, now running at 3.6% according to the central bank’s preferred measure, had ticked that box. Jobs, however, still had a way to go. Then came the employment figures for August — an increase of only 235,000, against an expected 733,000, making an early announcement on tapering harder to justify.

Powell and his colleagues need to keep several points in mind. It’s right to be guided by data, but a strategy for adjusting bond purchases gradually over a period of many months should be driven by trends and not by a single month’s figures. On that basis, regardless of the August jobs report, the labor market has seen very substantial progress toward full employment. Granted, the unemployment rate is still a bit higher than before the pandemic, and labor-force participation lower (perhaps because early retirement has taken some workers out of the labor force for good). But other measures, such as job openings, suggest a market for labor that is already unusually tight.

The pandemic setback might well mean slower-than-expected growth this quarter and next, but supply-side bottlenecks are likely to be a bigger factor than shrinking demand. If so, the Fed’s maximally accommodative monetary policy isn’t the right remedy. It gambles with pushing inflation higher in the short term, and it will add to financial-market fragility by keeping asset prices dangerously elevated and spurring the appetite for risk.

The key point is that the Fed now has to contend with two dangers, not one. The first is that the economy might stall and need renewed demand-side support; the other is that elevated inflation will persist and prove difficult to reverse. Although consumer prices rose by a relatively modest 0.3% in August over the previous month, this second danger should not be underestimated. The idea that the Fed can afford to wait until excessive inflation is an established fact and then move to reduce it — gradually and painlessly — is wrong. At that point, cutting inflation might be much harder than optimists suppose.

Already it’s being argued that the right response to this dilemma would be to increase the inflation target — partly because that would be wise in any event, but also because bringing inflation back down to 2% would be unduly disruptive to financial markets and prohibitively expensive in forgone output and jobs. This is how higher inflation gets entrenched, and why dealing with it after neglecting the problem too long is so hard.

The Fed needs to give itself the option of moving to curb inflation promptly should the need arise. That, in turn, means bringing its bond-buying program to a close sooner rather than later, so that the way is clear to start raising interest rates if need be. Even without quantitative easing, the Fed’s zero-interest rate policy will still be extremely accommodative. The program served a vital purpose, but the Fed now needs to acknowledge that the balance of costs and benefits has changed.

Editorials are written by the Bloomberg Opinion editorial board.

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