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Fed policymakers have split on inflation: 'Patient' or Aggressive'?

Fed policymakers have split on inflation: 'Patient' or Aggressive'?

  • Summary of the content
  • Fed policymakers are grappling with the extent of inflation threat as they prepare to make decisions on the Fed's future.
  • Minutes of September meeting due at 2 p.m. EDT (1800 GMT)

Oct 13, U.S. central bankers broadly agree they can begin to reduce their support for the economy immediately, but they are divided on how significant a threat high inflation poses, and - more importantly what they might need to do about it.

On Wednesday, the Federal Reserve will release the minutes of its Sept. 21-22 policy meeting, which officials said was their clearest sign yet that the days of crisis-era policy were over. Some indication of the intensity of that debate should emerge when the Fed releases the agenda for its next policy conference, where officials indicated that they believe the end of crises was near.

Most policymakers believe it is prudent to begin cutting back on the $120 billion in monthly asset purchases the central bank has been making to assist the economic recovery with inflation rising well above the Fed's comfort zone and the labor market recovering from the coronavirus epidemic.

Fed Chair Jerome Powell said last month that, as long as the job market data is "decent," he expects the wind-down of the Fed's purchases of Treasuries and mortgage-backed securities to begin next month and be completed by the middle of next year.

After a government report on Friday that showed that U.S. employers added 194,000 jobs last month, well below many economists' expectations, Fed Vice Chair Richard Clarida on Tuesday said the employment guidepost was "all but met," though he did not mention the beginning of the asset purchases in November.

He repeated Powell's prediction for the date of the end of "the taper," and the readout of September' s policy meeting will most likely cement that view. The Fed is scheduled to release the minutes of its meeting at 2 p.m. EDT (1800 GMT)

Most analysts believe the coming taper will be steady and "boring," as Philadelphia Fed President Patrick Harper put it.

Any indication in the minutes or elsewhere that policymakers intend to speed up or slow down the taper based on the pace of the economic recovery would be a departure from the predictable pattern the Fed followed in 2014, when it tapered the bond purchases made to restore the economy to health after the 2007-2009 financial crisis and recession, and would come as ominous to markets.

Perhaps more likely, though, is that the minutes will provide new colour to policymakers' inflation projections, and particularly whether or not they feel they will have to sacrifice their goal of achieving full employment in order to prevent inflation from spiraling upward.

Karen Dynan, an economics professor at Harvard University, said last week that "I don't think most central bank leaders believe they are facing that tradeoff right now," because they believe inflation will subside. "The choice will be relevant if we get to next year and inflation is uncomfortably high," said the chairman.

Economic projections released alongside the Fed's policy statement last month showed the central bank projecting inflation to rise by 4.2% this year, more than double its flexible 2% target. The United States will release new inflation data early on Wednesday.

"UNPLEASANT SITUATION"

Powell and Clarida have ruled out that possibility. Even though Fed policymakers are roughly equally divided on whether interest rate hikes will need to begin next year or in 2023, their projections are "entirely consistent" with the Fed's policy framework that aims to achieve both maximum employment and stable inflation, according to Clarida on Tuesday.

However, public comments from other policymakers, including the Fed's two longest-serving regional Fed presidents, suggest that there're some serious discussion under the surface.

St. Louis Fed President James Bullard fears that current high inflation may persist and embed itself in the economy, requiring a more "aggressive" response from the central bank. He worries that inflation may stay low or rise, and wants the Fed to finish tapering its asset purchases early next year so it can raise rates in spring or summer if necessary.

Chicago Fed President Charles Evans believes inflation will ease on its own as businesses work through supply bottlenecks that are putting upward pressure on prices. He advises his colleagues to "be patient" and says the rate of inflation won't be rising until late 2023.

Clarida, for one, said on Tuesday that he does not see any signs that rising wages are resulting in an unhealthy rise in inflation, but that "the big unknown" is how long the price-inflating supply bottlenecks last. He didn't give his current forecast for rate increases.

How policymakers' divergent views affect the actual timing of the Fed's rate hikes matters not only to those who follow and invest in markets, but also to Americans in general, including the millions of workers who were working before the epidemic but are no longer employed today.

If Fed policymakers feel they must raise rates to stop inflation before the economy has time to reach full employment, that may put a halt to the recovery.

If they delay rate hikes to give the labor market more of a chance to heal, but underestimate inflation's staying power in the meantime, they may have to hike rates significantly to make up for lost ground against inflation.

Tim Duy, an economics professor at the University of Oregon, said it's an "unpleasant situation" made worse by uncertainty about who will head the Fed when Powell'll retire in February, 2022. President Joe Biden has yet to say if he will resign Powell or pick someone else to lead the central bank.

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