Fed officials make it clear: This time is different
By Jeanna Smialek
Federal Reserve officials are preparing to pull back their economic help as inflation remains stubbornly high and the labor market swiftly heals, and they are signaling clearly that the last business cycle is a poor template for what comes next.
During the economic expansion that stretched from the global financial crisis to the start of the pandemic, the Fed acted very gradually — it slowly dialed back bond buying meant to help the economy, then only ploddingly shrank its balance sheet of asset holdings. Central bankers increased borrowing costs sporadically between 2015 and the end of 2018, raising them at every other meeting at the very fastest.
But inflation was muted, the labor market was slowly crawling out of an abyss, and business conditions needed the Fed’s support. This time is different, a series of Fed presidents emphasized Monday — suggesting that the pullback in policy support is likely to be quicker and more decisive.
Four of the central bank’s 12 regional presidents spoke Monday, and all suggested that the Fed could soon begin to cool off the economy. Central bankers are widely expected to make a series of interest rate increases starting in March, and could soon thereafter begin to fairly rapidly shrink their balance sheet holdings. The pace of policy retreat is still up for debate and officials reiterated that it will hinge on incoming data — but several also noted that economic conditions are unusually strong.
“The economy is far stronger than it has been, during any of my time in this role, and certainly, during any of the recoveries that we’ve been trying to navigate our policy through in recent memory,” Raphael Bostic, president of the Federal Reserve Bank of Atlanta, said in an interview with Yahoo Finance. Any risks “that our policies are going to lead to a contraction in the economy, I think they’re relatively far off.”
While it took the Fed a long time to begin shrinking its balance sheet last time, the central bank will probably move more promptly in 2022, Esther George, president of the Federal Reserve Bank of Kansas City, suggested during a speech.
“With inflation running at close to a 40-year high, considerable momentum in demand growth, and abundant signs and reports of labor market tightness, the current very accommodative stance of monetary policy is out of sync with the economic outlook,” said George, who votes on monetary policy this year.
Tricky questions lie ahead about how big the balance sheet should be, she noted. The Fed’s holdings have swollen to nearly $9 trillion, more than twice its size before the pandemic.
George estimated that the Fed’s big bond holdings were weighing down longer-term interest rates by roughly 1.5 percentage points — nearly cutting the interest rate on 10-year government debt in half. While shrinking the balance sheet risks roiling markets, she warned that if the Fed remains a big presence in the Treasury market, it could distort financial conditions and imperil the central bank’s prized independence from elected government.
“While it might be tempting to err on the side of caution, the potential costs associated with an excessively large balance sheet should not be ignored,” she said. She suggested that shrinking the balance sheet could allow policymakers to raise rates, which are currently set near-zero, by less.
Mary C. Daly, the president of the Federal Reserve Bank of San Francisco, also argued for an active — albeit still gradual — path toward removing policy help.
The Fed is not behind the curve, she said on a Reuters webcast, but it needs to react to the reality that the labor market appears at least temporarily short on workers and inflation is running hot. Prices picked up by 5.8% in the year through December, nearly three times the 2% the Fed aims for on average and over time.
“We’re not trying to combat some vicious wage-price spiral,” Daly said. Still, she said she could support a rate increase as soon as March, and hinted that four rate increases could be reasonable, a path that would slow things down while “not pulling away the punch bowl completely and causing disruptions.”
Even so, she said it would be “misinformation” to suggest that officials are coalescing around a clear path forward — the Fed will have to figure out how rapidly rates will increase as it learns more about the economy.
Wall Street economists increasingly expect a rapid pace for rate increases this year: Goldman Sachs and J.P. Morgan both expect five rate moves in 2022, and some Fed watchers have suggested as many as seven are possible. Markets are pricing in a small but meaningful chance that the Fed is going to raise rates by a half-point in March, instead of a more typical quarter-percentage-point increase.
Officials have been careful to emphasize that they do not know what is going to happen next with policy because the economy is so uncertain — rents are rising and supply chains remain messy, which could keep inflation elevated, but government support programs are waning, which could weigh down demand.
“We’re not set on any particular trajectory,” Bostic said.
Bostic had suggested in an interview with The Financial Times over the weekend that a half-point rate increase could be appropriate this year, a rapid approach to withdrawing policy help that was never used in the last expansion.
He said on Yahoo on Monday that he does not prefer a supersize increase in March at this point, though he has “increasingly” seen that meeting as the right time for the Fed to begin raising rates. Like George, Bostic also emphasized that this time was different when it comes to the Fed’s balance sheet.
“The economy is stronger,” he said. “And we have that previous experience that gives us some guidance as to how markets are likely to respond as that balance sheet shrinks. So I think we can be more robust in terms of how we do that.”