Federal Reserve officials last month worried that disrupted supply chains were raising the risks of more persistent inflation as they firmed up plans to reduce their bond-buying stimulus program next month and conclude it by the middle of next year.
Minutes of their Sept. 21-22 Fed meeting, released Wednesday, revealed a stronger consensus over scaling back the $120 billion in monthly purchases of Treasury and mortgage securities amid signs that higher inflation and strong demand could call for tighter monetary policy next year. The bond purchases have been a key piece of the Fed’s effort to stimulate growth since the coronavirus pandemic disrupted the U.S. economy last year.
Under plans discussed last month, the Fed would reduce its purchases by $15 billion a month, divided proportionally between Treasury and mortgage bonds. Officials discussed starting the taper in mid-November; if they follow the schedule penciled out last month, purchases would conclude by June.
That schedule for phasing out the Fed’s stimulus program is somewhat faster than investors had anticipated just a few months ago. It partly reflects how this year’s surge in inflation is lasting longer than central bank officials and private-sector economists anticipated.
Officials don’t want to be in a position where they feel compelled to raise rates at a time when they are still fueling monetary stimulus by purchasing assets.
The minutes said that several participants at last month’s meeting preferred to reduce the purchases even faster. Those officials have been eager to conclude their asset buying to get flexibility to raise rates next year, if needed, because they think inflation may continue to run above the Fed’s 2% target.
The Fed cut its short-term benchmark rate to near zero when the coronavirus pandemic hit the U.S. economy in March 2020.
Officials debated last month when the Fed might need to lift rates from near zero. The minutes said an unspecified number of officials raised the possibility of beginning to raise rates by the end of next year because they expected the labor market and inflation to meet goals laid out by the Fed one year ago. Some of these officials thought inflation would remain elevated through next year.
Another group was more optimistic that inflation would come down to the Fed’s 2% target on its own. These officials thought the economy was likely to warrant rates remaining at or near their current setting over the next two years. Raising rates too soon and too quickly, these officials said, could undermine the Fed’s recent commitments to keep inflation from drifting below its 2% goal.
New projections released at the end of last month’s meeting showed half of the 18 officials that participated expected the economy to require an interest-rate increase by the end of 2022.
Rising vaccination rates and nearly $2.8 trillion in federal spending approved since December has produced a recovery like none in recent memory. Inflation has soared this year, with so-called core prices that exclude volatile food and energy categories up 3.6% in August from a year earlier, using the Fed’s preferred gauge. The gains largely reflect disrupted supply chains and shortages of labor and materials.
The Labor Department reported Wednesday that a separate index of core inflation rose 4% in September from a year earlier, matching the year-over-year increase reported in August. Since May, overall consumer inflation, measured on a year-over-year basis, has risen at the fastest pace in 13 years, according to the Labor Department.
Price pressures this year were initially concentrated in a handful of categories including used cars and airfares that could be traced directly to the reopening of the economy. Wednesday’s report showed some broadening of price gains. Increases in two categories—housing and restaurants—stood out because they tend to more closely reflect the amount of slack in the economy, or what economists refer to as "cyclically sensitive inflation."
The Fed’s staff forecast prepared last month revised its inflation projection higher, but bank economists still expected this year’s rise in inflation to prove transitory, the minutes said. That forecast called for inflation to slow to slightly below the Fed’s 2% target next year amid a sharp drop in import prices before returning to 2% by 2024.
"The staff interpreted recent inflation data as indicating that supply constraints were putting a larger amount of upward pressure on prices than previously anticipated," the minutes said. Compared with the previous projection made in late July, "these supply constraints were also expected to take longer to resolve."
The minutes also indicated that staff economists pointed to a risk that households’ and businesses’ expectations of inflation in the future "would move appreciably higher," which would be an alarming development for central bank officials because they believe such inflation expectations play important roles in influencing actual inflation.
Atlanta Fed President Raphael Bostic said in public remarks Tuesday it was time to stop describing recent high inflation as transitory, which he called a "dirty word." For emphasis, he dropped $1 into a glass jar with the label "transitory" on it each time he used the word.
"It is becoming increasingly clear that the feature of this episode that has animated price pressure—mainly the intense and widespread supply-chain disruptions—will not be brief," he said. "By this definition, then, the forces are not transitory."
During a moderated discussion on Sept. 29, Fed Chairman Jerome Powell conceded that the Fed is facing a situation it hasn’t encountered in a very long time, in which there is tension between the central bank’s two objectives of low, stable inflation together with high employment.
"Managing through that process over the next couple of years is…going to be very challenging because we have this hypothesis that inflation is going to be transitory. We think that’s right," he said. "But we are concerned about underlying inflation expectations remaining stable, as they have so far."
Mr. Powell has often approached his job trying to position the central bank’s policy stance to manage against risks of weaker-than-expected growth or stronger-than-expected growth. That means the Fed might shift its setting not just because the economy weakens or strengthens but also because the risks around the outlook change.
"The inflation numbers have been bad, and the supply chain information is pretty bad. It looks less transitory and like some of these supply chain difficulties will persist for a while," said William English, a former senior Fed economist who is now a professor at the Yale School of Management.
"The key question is when does that begin to weaken the public’s sense that inflation will come back down to 2%?" said Mr. English. "The inflation risks look larger now than they did a few months ago."
Fed Vice Chairman Richard Clarida said Tuesday that the Fed would need to raise interest rates if it sees evidence households and businesses were beginning to expect recent inflationary pressures to persist. "Monetary policy would react to that," he said. "But that is not the case at present."
Uncertainty surrounding the economic and policy outlook is even greater than usual right now because President Biden has yet to announce who should lead the central bank after the terms of Messrs. Powell and Clarida expire early next year.