The Federal Reserve expects inflation will climb to 3.4 percent this year, higher than the central bank’s previous forecasts, while also projecting for the first time that there could be two interest rate hikes in 2023.
In March, the Fed predicted inflation would be 2.4 percent for this year. Moreover, earlier Fed estimates didn’t project an initial interest rate hike until 2024.
The new snapshots of the economy come as the Fed and White House are facing increasing criticism from the GOP and some economists that trillions of dollars of stimulus spending, combined with low interest rates and the Fed’s other economic supports, are now overheating and endangering the economy.
For its part, the Fed expects prices for certain goods and services to continue to rise over the next few months, especially in industries with backlogged supply chains. However, the Fed also expects that the labor market will keep building strength. And while the central bank isn’t ready to stem inflation by raising interest rates just yet, Chair Jerome H. Powell sent the message that the Fed is keeping a close eye on inflation.
“Shifts in demand can be large and rapid,” Powell said at a Wednesday news conference. “Inflation could turn out to be higher and more persistent than we expect.”
Powell added that the Fed would be ready to respond quickly if inflation is broader or more persistent than officials currently think. On Wednesday, the Fed kept interest rates near zero, as expected.
The news that the Fed planned to end record-low interest rates sooner than projected weighed on markets. The Dow Jones industrial average dropped 266 points or 0.8 percent, and the tech-heavy Nasdaq composite fell 33 points or 0.2 percent.
Overall, the Fed’s latest projections showed a more optimistic take on the economic recovery. Officials expect economic growth to hit 7 percent this year, which would be the fastest calendar-year expansion since 1984, up from the 6.5 percent growth projection the Fed released in March.
The Fed also pointed to more widespread coronavirus vaccinations for helping boost economic activity and employment. The labor market is still healing from the depths of the pandemic and has yet to recover 7 million jobs. Yet according to the Fed’s estimates, the unemployment rate could fall to a pre-pandemic level of 3.5 percent by 2023.
“I am confident that we are on a path to a very strong labor market,” Powell said.
Recent benchmarks have shown an increase in consumer prices, including for products like used cars and lumber. However, officials from the Fed and the Biden administration say those increases are largely expected as the economy emerges from the sharp, pandemic-induced downturn, when prices dropped.
A separate measure of inflation, released earlier this month by the Bureau of Labor Statistics, showed that prices rose 5 percent in May compared with a year ago. A large share of May’s inflation gains came from the car market. The price of used cars and trucks continued to surge, rising 7.3 percent in May compared with April. That followed a 10 percent increase in April.
On Wednesday, Powell said he expected certain categories — like planes, hotels and lumber — would see their prices simmer down over time.
“We expect those prices will get back up to where they were, but there’s no reason to think they‘re going to keep going up a lot,” Powell said. “Because if they are, people will build new hotels; there’s no reason for supply and demand to be out of whack in the hotel business over any period of time.”
However, Republican lawmakers argue that the Fed could lag behind the curve when it decides to raise interest rates and that inflation could jump to dangerous levels in the meantime.
“We are seeing substantial increases in inflation, which means the prices of everyday goods are going up for families in Florida and across the nation,” Sen. Rick Scott (R-Fla.) said. “Government shouldn’t work this way.”
Joining that chorus is former treasury secretary Lawrence H. Summers, a Democrat who has said that policymakers are critically underestimating inflation’s threat to the economy and that they need to adjust their policies to meet reality.
The current treasury secretary, Janet L. Yellen, responded to Republican criticism Wednesday while testifying before a Senate committee hearing.
“As the economy is opening back up again, prices are now moving back toward normal levels in leisure, hospitality, airfare and the like. In most cases, prices remain below pre-pandemic levels — but they’re rising, and that’s some of what’s going on here,” said Yellen, the former Fed chair. “We’re going to monitor this very, very carefully.”
The White House budget predicted 2 percent inflation for this year, an estimate based on projections from February that were in line with those of Wall Street analysts. Yellen said Wednesday that the White House’s mid-session budget update — likely to come this summer — would be revised upward as inflation outstrips expectations. She also acknowledged that businesses are struggling to hire workers.
Investors and economists are searching for any small signs that the Fed is more seriously looking to pare back its financial supports for the markets, through its asset purchase program that buys $120 billion in bonds every month. Fed leaders aren’t ready to pull back the support just yet, but there are plenty of questions about when and how it will signal openness to a slowdown.
Powell and other Fed leaders hope those signs land gently. And they know the cost if there’s more of a thud. In 2013, Fed Chair Ben Bernanke hinted at a wind-down in asset purchases that the Fed began because of the Great Recession. A panic in the markets ensued, triggering the infamous “taper tantrum.”
On Wednesday, Powell said that Fed policymakers were “talking about talking about” tapering and that there would be plenty of advance warning. He also drew a clear line between scaling back asset purchases and eventually raising interest rates, also known as “liftoff.”
“Liftoff is well into the future,” he said. “We’re very far from maximum employment. It’s a consideration for the future. The discussion now is about the path of asset purchases.”
The Fed won’t raise interest rates until there’s been significant progress in the labor market, which is still down at least 7 million jobs. The economy gained some 559,000 jobs in May. Still, at its current pace, the labor market won’t recover its pandemic losses until the summer of 2022.
In certain pockets of the economy, a handful of overworked industries are short on help. Meanwhile, some workers are weighing the prospect of a $15-an-hour starting wage or federal unemployment benefits in their decisions about returning to work. Many Americans have also left the labor force and opted for an early retirement. The changing dynamics all raise questions about what full employment looks like and what permanent changes the pandemic will have on workers and businesses alike.
Fed officials didn’t change their unemployment-rate expectation for this year, keeping it at 4.5 percent. Powell said some people still aren’t returning to work because of pandemic fears, child care responsibilities and extended federal unemployment benefits.
“You put all those together, and I would expect we would see strong job creation building up over the summer and going up into the fall,” Powell said.
Still, Powell cautioned against taking a victory lap too soon. He noted that the pandemic is not yet over. And he said it would take time — and patience — for the Fed to have a full picture of inflation and the labor market.
“We really don’t have a template or any experience of a situation like this,” Powell said. “We have to be humble about our ability to understand the data.”