the money game

The Federal Reserve Just Declared War Against Inflation

Photo: Will Oliver/EPA-EFE/Shutterstock

Since the start of the pandemic, the federal government has propped up the economy in ways that are visible — about $5 trillion in direct stimulus programs, like the Paycheck Protection Program — and ways that are less so, like the decision to keep borrowing costs at next to nothing. Today, Federal Reserve officials voted to speed up the end of the invisible stimulus in direct response to the rise in inflation — a surge in prices that’s come, in part, as a direct response to all the extra money that’s flooded the economy during the last two years.

The decision by the Federal Open Market Committee today will not translate into an immediate change in the price of gas or even the interest rate on a credit card — but what it does signal is that the Fed’s chair, Jerome Powell, is willing to take more drastic measures to keep prices from rising out of control. From the start of the pandemic until October, the Fed was buying $120 billion a month in debt — a way to suck risk out of the markets and keep the cost of borrowing money at essentially zero. Last month, when it still viewed inflation as a temporary phenomenon, it took a small step toward ending that stimulus by tapering its buying spree by $15 billion. Today, the central bank decided to double the pace at which it’s been cutting back on government and mortgage debt it’s buying, reducing purchases by an additional $30 billion this month. This is coming as the numbers of vaccinated adults continues to rise and there’s less and less appetite for the kind of dramatic shut-downs that defined the early days of the pandemic. “People are learning to live with this,” Powell said during a press conference after the announcement. “More and more people are getting vaccinated, so people who get the new variant, it affects them much less than than then it tends to affect, in the aggregate, people who are not vaccinated. So the more people get vaccinated, the less the economic effect.” Even with the omicron variant spreading — and the delta variant still dominating US infections — the relative sturdiness of the economy speeds up the timetable for the end of the bond-buying program to March and sets the stage for the Fed to raise interest rates next year.

Why is this happening now?

Powell is moving faster to end the Fed’s stimulus program now because inflation is threatening to derail the economic recovery 22 months after the start of the COVID pandemic. The central bank is focused on two things: keeping employment high and prices stable. With the unemployment rate at about 4.2 percent and more people returning to the workforce, the Fed is obligated to tamp down the cost of goods in order to keep basic necessities from slipping out of reach for most people. Prices for consumers rose an average of 6.8 percent in November, the fastest climb since 1982, driven by a surge in gas and home heating prices, rent, and food. To put that in context, the inflation rate has hovered around 2 percent for most of this century. It’s an increase that, for most people, is outpacing any wage gains they would have seen this year.

Up until this month, the Fed has been cautious about moving too fast to tame inflation. The reason behind the surge in prices can be traced back to a backup in ports and trucking, oil production slowdowns, and even one-off events like last year’s bankruptcy of car rental company Hertz. But as recently as this summer, the economic consensus was the inflation would only rise a little bit above the 2 percent mark. The steep rise in the price of everything has caught economists off guard and prompted the Fed to move more quickly.

How does the taper work?

The Fed has a lot of ways to keep the economy flush during crises. In addition to keeping rates low, it can act as a backstop for all kinds of debts, taking on the risk that a company or even a municipality might not be able to pay back the money it borrowed — a concern that banks or bondholders might not want to deal with. But the pandemic also brought on novel ways of keeping the economy afloat. The PPP, which was a congressional program it oversaw, was one such way, though it usually goes directly into the debt markets and buys up bonds. This gives Wall Street more leeway to lend to businesses, which rely on credit to stay afloat. All of this floods the economy with money.

But when the Fed wants to push money out of the system, its main tools can be blunt. While interest rates haven’t risen yet, any hike in the Fed’s benchmark rate makes borrowing money more expensive for everyone, whether you’re the biggest bank in the world or an 18-year-old taking out a student loan. Most Fed officials are looking at three rate hikes next year, a 0.75 percent rise in base borrowing costs. The taper that’s accelerating now is essentially a transition period. Every debt the Fed doesn’t add to its balance sheet will end up being owned by an investor, who’s going to assume that risk and come up with a price for it.

Right now, Wall Street is factoring all this in, but the main risks could be to the job market. If the amount that companies have to pay in interest goes up, that means there will be less for payroll, which could cause layoffs to rise. During the presser, Powell was less concerned about the unemployment rate than he was the employment participation rate — the measure of people who’d like to be working, but can’t. This year, companies have been able to rake in record profits, and fat corporate margins have meant broad plans for more raises next year. It’s possible that the extra financial cushioning can keep people from losing their jobs, but it depends on whether the Fed’s plans work in the first place — or if it will have to take more drastic measures in the future.

Update: This post was updated to include Federal Reserve Chair Jerome Powell’s comments during a press conference.

The Federal Reserve Just Declared War Against Inflation