Federal Reserve Chair Jerome Powell surprised investors on Tuesday when he told the Senate Banking Committee that it was time to stop talking about “transitory” inflation and start discussing a faster winding-down of the Fed’s bond-purchase program. It was an unusually abrupt shift of messaging by Powell’s cautious standards, but right nonetheless.
Inflation is running faster than the Fed had expected earlier this year, and it has spread beyond the sectors hit worst by the pandemic. Most measures show that the labor market is tight, even though the number of people employed hasn’t come all the way back, so wages are moving up. This suggests that a higher-than-targeted inflation rate will persist longer than the Fed had hoped. As things stand, monetary policy is still delivering an extremely strong stimulus, with short-term interest rates close to zero and a still-enormous bond-buying program only now being dialed back. The additional, gradual tightening that Powell hinted at makes sense.
Arguably, financial markets have gotten ahead of the Fed, and Powell is simply taking his cue from them. Investors had already priced in a somewhat bigger and faster rise in interest rates next year than the Fed’s policy makers have indicated. In this sense, the timing of Powell’s comments, ahead of the next meeting of the central bank’s policy-making committee on Dec. 14, was more surprising than the thinking that lies behind them.
Doesn’t the new omicron variant of Covid-19 pose the risk of a pandemic resurgence and further economic setbacks? It’s possible, but too soon to say. As throughout this crisis, the Fed needs to keep an open mind and be ready to adjust policy accordingly. Powell’s comments underlined the point. Confirmation that the Fed hasn’t tied itself to a single theory of what’s going on and a fixed policy to deal with it is welcome in its own right. If the omicron variant starts a new cycle of shutdowns, the Fed will have to rethink.
Keep in mind, though, a point that weighs in favor of a somewhat faster reduction of the Fed’s quantitative-easing program regardless of the new variant. If additional monetary stimulus should be needed, bond purchases can be promptly stepped up to provide it. If, on the other hand, the surge in inflation gets out of hand, the Fed can’t resort to higher interest rates as fast as it might like while QE is still in place — not, at any rate, without startling financial markets and possibly losing control of events. The Fed needs to get to a point where a measured rise in interest rates, if necessary, can be started without delay. Tapering asset purchases by $30 billion a month instead of $15 billion would finish the program, all being well, by March. That’s better than foreclosing the option of higher rates until summer.
Wise central bankers keep their minds, and their options, open. If and when the situation demands, they should be ready to respond. Powell’s pivot, whether you call it surprising or not, is good news.
Editorials are written by the Bloomberg Opinion editorial board.
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