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The Fed’s inflation challenge: Getting the policy and the messaging right

Fed officials have worked to clarify that their meaning behind ‘transitory’ inflation is quite different from the public’s

Federal Reserve Chair Jerome H. Powell testifies during a House Financial Services Committee hearing on Capitol Hill on Dec.01, 2021. (Jabin Botsford/The Washington Post)
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To keep her business running, Joan Scott must contend with a slew of economic challenges — from manufacturing delays to transportation logistics — pinching her lighting supply company in Huntsville, Ala., and forcing her to raise prices. When Scott asks her suppliers of LED bulbs and other lighting equipment when they expect their own costs to return to normal, she’s often told, “We don’t know.”

Nobody suggested it was going to pass anytime soon.

The uncertainty at Scott Lighting Supply Co. is, in many ways, at the root of the Federal Reserve’s shift in how it has been talking about inflation. For much of the year, the Fed and its leaders maintained that price increases would be “transitory,” or temporary, and more limited to sectors hit hard by the pandemic. Over time, that message was increasingly hard to square with data surfacing in the economy. Some Fed watchers also say the message appeared out of touch with the wider public, because “transitory” gives the impression that rising prices would be short-lived.

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“As small businesses, I don’t think we pay as much attention to what [Fed officials] say as to what we see,” Scott said. “I can’t sit and go, ‘Okay, they’re forecasting it to go away,’ and set my prices for it to be ‘transitory.’ I’ve got to do it today.”

Over the past few months, Fed officials have worked to clarify that their meaning behind “transitory” inflation is quite different from the public’s. They also have acknowledged that their initial expectations for inflation have missed the mark, compared with earlier predictions. For example, when Federal Reserve Chair Jerome H. Powell was recently asked at a congressional hearing whether he stood by earlier testimony that price increases are not particularly large or persistent, Powell responded, “No, that is no longer my view.”

The messaging challenge will follow the Fed into the final stretch of the year and beyond, especially since there is no clear timeline for when supply chain bottlenecks or strong consumer demand will ease back toward normal. Last week, a key inflation benchmark, the consumer price index, showed inflation climbed 6.8 percent in November compared with last year, largest rise in nearly four decades. The same index rose 6.2 percent in October, compared with a year earlier.

“They’ve got a problem because inflation is likely to still be ‘transitory’ in the common economic sense,” said Adam Posen, president of the Peterson Institute for International Economics. “But they set themselves up and they trapped themselves, and it makes it harder for them to say [to the public], ‘Now look through this.’ ”

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Inflation has increasingly become a hot-button political issue and a top economic concern for American households. Republicans argue that Democrats’ sprawling stimulus measures are overheating the economy and that the Fed will be behind the curve, and risk a recession, once it decides to raise rates.

The Biden administration, for its part, has taken steps to address gas prices and argues that its investments in U.S. infrastructure and jobs will bring prices down over the long term. Last week, President Biden talked about the impending November inflation figures, in an attempt to get ahead of them.

“The information being released tomorrow on energy in November does not reflect today’s reality, and it does not reflect the expected price decreases in the weeks and months ahead, such as in the auto market,” Biden said Thursday, before the latest inflation data was released.

Along with keeping prices stable and supporting maximum employment, the Fed must also clearly communicate how it views the economy — for the markets, households and businesses alike. The Fed’s view continues to be that inflation won’t become permanently entrenched in the economy. But that doesn’t resonate well with households or businesses who have been dealing with price pressures for months, and expect to for months to come.

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“I think it might not have acknowledged enough how painful it was for people going to the store, that maybe it seemed dismissive in a way,” said Stephanie Aaronson, who spent almost two decades as a Fed economist and is now at the Brookings Institution. “Maybe ‘transitory’ is just a bad word. It has this sense of ‘fleetingness,’ but that isn’t actually what they meant.”

Testifying before the Senate Banking Committee in late November, Powell reflected on the use of the word “transitory” and said it was “probably a good time to retire that word and try to explain more clearly what we mean.”

“It’s become a word that’s attracted a lot of attention that maybe is distracting from our message, which we want to be as clear as possible,” Powell said earlier that month. “We understand completely that it’s particularly people who are living paycheck to paycheck or seeing higher grocery costs, higher gasoline costs — when the winter comes, higher heating costs for their homes. We understand completely what they’re going through.”

The Fed is navigating a tricky phase of the economic recovery. While prices remain high across a broad sector of categories, from groceries and used cars to Christmas trees, the job market is making strides and Americans are continuing to spend big. Retail sales surged in October, with the expectation that the trend would grow going into the holiday season.

Fed policymakers will gather this week for their final meeting of the year. They’re expected to speed up the “tapering” of a vast bond-buying program that has supported the markets for much of the pandemic, in part because policymakers see so much improvement in the economy, alongside rising inflation.

Fed leaders will also release new economic projections that could hint at a faster timeline for when they’ll begin to raise interest rates, which were slashed to near zero at the start of the pandemic. The Fed’s primary tool for combating inflation is through higher interest rates.

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The Fed also stakes much of its public trust and transparency in simple communication, which can be challenging given there’s no playbook for anything like the covid era.

In public remarks, Powell has said that, like many forecasters, the Fed didn’t expect supply-side problems to last for so long. The delta variant of the coronavirus exacerbated supply chain issues around the world and slowed the recovery’s momentum. Powell and his colleagues have long said that the coronavirus will ultimately dictate the path of the economy, while emphasizing vaccinations as a crucial public health and economic tool.

Historically, the Fed moves slowly and deliberately, but the pandemic has revealed how quickly things can change in the economy. Fed officials say they can be patient enough to wait for data, but they can also act swiftly or change tone or policy when the time is right.

“We see higher inflation persisting, and we have to be in position to address that risk should it become really a threat to — should it create a threat of more persistent, longer-term inflation,” Powell said in November. “And that’s what we think our policy is doing now. It’s putting us in a position to be able to address the range of plausible outcomes.”

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Still, some economists argue that inflation has been sending off warning signals for some time now. All year, Lawrence H. Summers, who served under Presidents Bill Clinton and Barack Obama, warned that the scope of Democrats’ stimulus measures would overwhelm the economy and spur unsustainable inflation. Obama administration economist Jason Furman told CNBC last month that the Fed “will need to shift off their game plan and raise rates faster than they are currently telegraphing.”

“When you’ve made mistakes or have been wrong, it’s almost always best to evolve your position rapidly, rather than to defend it for the sake of your credibility,” Summers told The Washington Post.

Part of the Fed’s initial “transitory” argument was that inflation would move through parts of the economy hit hardest by the pandemic, including lumber and used cars, as well as airfare and hotels. However, over time, rent went up, as did the cost of medical care. The November consumer price index report showed broad-based increases spanning just about every sector, from pork, poultry and produce to housing and sporting goods.

And it became clear that prices weren’t only being hamstrung by the supply side of the equation, but also by demand. During a webinar hosted by the American Enterprise Institute, outgoing Fed governor Randal K. Quarles said, “This is not a question of demand at pre-covid levels and supply taking a while to reach back up to that pre-covid capacity.” Rather, he said, the economy is experiencing “sustained higher demand.”

“This is … not really a bottleneck story anymore,” he said.

At Scott Lighting Supply Co., Scott said she is being squeezed by the global supply chain backlogs, since so many of her products are imported from overseas and through the Port of Los Angeles. But she said that’s only part of what’s driving her prices up.

“It’s not only the supply chain issues or trucking,” Scott said. “There’s so many different factors, like having to pay more for employees. It goes all the way down the line … and it causes everything to go up.”