by Jeanna Smialek / via The New York Times
The Federal Reserve lifted its key interest rate by a quarter of a percentage point on Wednesday as policymakers took their first decisive step toward trying to tame rapid inflation by cooling the economy.
The Fed had kept rates near zero since March 2020, and the decision marked its first increase since 2018. Policymakers also projected six more similarly sized increases over the course of 2022 as inflation comes in at a 40-year high.
“With appropriate firming in the stance of monetary policy, the committee expects inflation to return to its 2 percent objective and the labor market to remain strong,” the Fed said in its March statement, noting that the committee “anticipates that ongoing increases in the target range will be appropriate.”
The Fed is at an inflection point after two years of trying to help the economy to recover from the damage inflicted by the global pandemic. While the coronavirus continues to disrupt commerce around the world, the United States economy has staged a swift recovery. America’s job market has rebounded rapidly from steep pandemic job losses that had pushed unemployment to 14.7 percent, and businesses are now struggling to find workers.
A surge in consumer spending has helped to push the rate of inflation to levels not seen since the 1980s. Instead of echoing the anemic slog back from the 2007-9 recession — one that kept millions of applicants out of work and left inflation tepid despite years of rock-bottom rates — the pandemic bounce-back has been vigorous.
Judging by inflation, it may even have too much heat, which is why the Fed is trying to slow the economy down to a more sustainable pace.
“The economy is very strong,” Jerome H. Powell, the Fed chair, said at a news conference following the announcement, calling recent growth “robust” and the outlook “solid,” while saying that the labor market is “extremely tight.”
“Wages are rising at their fastest pace in many years,” he said, noting that inflation is “well above” the Fed’s target and that supply chain disruptions have been larger and longer-lasting than expected. Higher energy prices are pushing up inflation even more, just as price pressures broaden.
Higher interest rates will trickle out through markets to make mortgages, car loans and borrowing by businesses more expensive. That is expected to slow consumption and investment, reducing demand in the economy and — Fed officials hope — eventually weighing down surging prices.
Central bankers plotted a more aggressive plan for controlling inflation than in December, when they last released economic projections. Officials now expect to raise rates to 2.8 percent by the end of 2023, based on the median estimate, up from 1.6 percent in their prior projections. That is high enough that, by the Fed’s own estimates, it might amount to actually tapping the brakes on the economy — not just taking a foot off the gas pedal.
The Fed’s Current Projections
“They knew their policy didn’t match the economic backdrop, and this is catch-up,” said Priya Misra, the head of global rates strategy at TD Securities. “They’re giving a tough message that they expect they will have to slow growth to bring inflation under control.”
With the help of their policy changes, central bankers still expect inflation to begin to slow on its own this year, but they have become concerned that a meaningful deceleration will take time.
The Fed’s quarterly economic projections, released alongside the rate decision, showed that officials expected inflation to hover around 4.3 percent at the end of 2022. While that is less than 6.1 percent increase in the 12 months through January, it is well above the Fed’s goal of 2 percent.
James Bullard, the president of the Federal Reserve Bank of St. Louis, voted against the committee’s decision because he favored a larger interest rate increase of half a percentage point.
The Fed directly addressed the possible economic implications of Russia’s invasion of Ukraine in its statement.
“The invasion of Ukraine by Russia is causing tremendous human and economic hardship,” Fed officials said in their statement. “The implications for the U.S. economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.”
Mr. Powell, speaking at the news conference, noted that the invasion of Ukraine and related events are a “downside risk.”
While the Fed is raising rates partly because inflation is so rapid, officials have also taken solace in labor market progress. Unemployment has dropped sharply, job openings are plentiful, and there are too few workers to go around.
The Fed aims for both price stability and maximum employment, and central bank officials have indicated that the labor market is meeting that latter goal, though they hope more workers will return as fears of catching the coronavirus ease and as child-care issues tied to school shutdowns and other virus mitigation measures fade.
A booming job market has helped to push wage growth higher because employers are competing for workers and trying to retain their existing employees by paying more. Higher compensation could fuel inflation down the road, some economists worry: It gives workers more wherewithal to spend, and it leaves firms trying to cover climbing labor costs.
The Fed is trying to avoid a situation in which both consumers and companies come to believe that prices will continue to increase briskly year after year. Expectations for higher inflation could prompt consumers to accept cost increases, could lead workers to ask for bigger raises and could give businesses the confidence to continue lifting prices.
The question is just how far the central bank will have to go to make sure that price gains slow down and inflation expectations remain under control.
Central bankers are hoping to engineer a soft landing: A situation where they can slow growth down to a maintainable level without derailing the economy and causing a recession. Mr. Powell has been clear that he is willing to do whatever it takes to achieve price stability.
Asked about that calibration on Wednesday, Mr. Powell said that, in his view, “the probability of a recession within the next year is not particularly elevated.” He cited strong demand, a healthy labor market and other conditions that he said were “signs” that the economy will be able to flourish “in the face of less accommodative monetary policy.”
In the 1980s, the Fed pushed interest rates to high levels — above the level of inflation — in order to slow the economy and weigh down inflation. In the process, it caused unemployment to rise to nearly 11 percent.
Most economists have said that such a painful repeat is unlikely, though many have warned that a gentle, easy end to the current inflationary burst is not assured.
“It is way too soon to say it’s a pipe dream: It’s been a crazy year,” Jason Furman, an economist at Harvard University, said earlier this week of the possibility of a soft landing. “It feels, with every passing month, increasingly unlikely.”
For many people, the Fed’s decision to raise interest rates has already been palpable: Mortgage rates have climbed thanks to the central bank’s signal that it will raise interest rates and, in coming months, begin to trim its balance sheet of bond holdings.
Whether they move up more depends on how fast and how high the Fed plans to raise rates, and how it approaches its balance sheet runoff plans.
“I could see mortgage rates moving either direction, depending on how they answer those questions,” Mike Fratantoni, chief economist for the Mortgage Bankers Association, said before the Fed meeting.
As higher rates weigh on hiring, they could eventually slow wage growth, and higher borrowing costs are likely to keep asset prices — including stock and home prices — from rising as much, as they draw buyers and investors away.