The Federal Reserve needs to take action

Federal Reserve officials, confronting developments and an outlook they seem to have not anticipated, face tricky decisions as they finalised their policy deliberations on Wednesday. These centre on updating their individual projections and converging on whether — and if yes, how — to start a necessary policy pivot that unfortunately conflicts with the framework the central bank adopted recently to guide and signal monetary policy intentions. If they were market traders or CEOs of competitive private companies, the answer would be clear: Start reducing exposure to a now more risky posture by moving forward with a partial pivot in light of the changed circumstances, thereby keeping their options open and better balancing risk. That is not what is likely to transpire, however. Instead, the Fed will most likely fall short of what is required and risk exacerbating the challenges it — and the economy — face in the longer term.
Like many others, the Fed’s projections had anticipated a slower economic recovery with inflation limited to temporary and rapidly reversing “transitory” factors such as base effects and demand-supply imbalances. In such a world, the new policy framework adopted in 2019, which involves a shift from forecast-based to outcome-based policy actions, would have been appropriate, providing the Fed with a foundation for a warranted multiyear glide path for a very slow and orderly policy transition.
Under this scenario, the earliest the Fed would have initiated broad conversations about tweaking its policy signaling would have been at the end of August during the Jackson Hole Symposium of central bankers in Wyoming — reinforcing their strong desire to avoid a repeat of the disruptive 2013 “taper tantrum” and the embarrassing policy
U-turn at the end of 2018 and the start of 2019. Following that would have been a multi month period of designing a taper, an equally long period of actual gradual taper in 2022 and the initiation of a cycle of very gradual rate increases in 2023 and 2024.
What is transpiring so far, however, is a persistently much hotter inflation outlook and, with that, the need for an accelerated timeline. The evidence is piling up, and not just for the Fed. The Labor Department reported that the producer price index rose to a 6.6% gain on an annual basis, above consensus expectations. That followed higher-than-expected readings last week in China’s PPI and the US consumer price index.
With the supply side under growing pressure, more companies are fearing longer-term disruptions to supply chains, worker availability, transportation and inventory management. Some are also increasing wages to both attract workers and retain them. The inclination to pass through these increases to prices is considerable, aided and abetted by the greater pricing power that several companies possess coming out of the pandemic because of both supply changes such as industrial concentration and abundant demand. In such an environment, the world’s most powerful central bank should ease its historically astounding policy stimulus. This would start immediately with a small taper of the $120 billion of monthly asset purchases — a prelude to their eventual elimination over the next 12 months— and the subsequent start of a slow lifting of interest rates from near zero.

—Bloomberg