The Federal Reserve raised interest rates for the first time in the pandemic on Wednesday, while signaling far more hikes and warning that inflation would remain high through the rest of the year.
The Fed Board has faced criticism that it has underestimated inflation over the past year, and now even more uncertainty lurks. Energy prices are spiking because of the war in Ukraine, and coronavirus surges are shutting down major Chinese manufacturing hubs, worsening global supply chain snarls that are pushing prices higher.
“Inflation is likely to take longer to return to our price stability goal than previously expected,” Fed Chair Jerome H. Powell said during a news conference Wednesday. Later he added, “We’ll deal with what comes, whether it’s better or worse.”
Inflation has a long way to fall before it comes close to normal levels, but the Fed has to avoid intervening too forcefully or abruptly, which could cause a recession. The Fed expects inflation will remain high, hitting 4.3 percent at the end of the year, even taking into account interest rate hikes, according to new projections released at the end of the Fed’s two-day policy meeting.
Markets initially fell on the rate hike news but recovered as Powell spoke during a news conference, with the Dow Jones industrial average closing up 1.5 percent and the Nasdaq closing up 3.8 percent.
Raising interest rates has a cooling effect on the economy, because it increases the costs associated with a wide range of lending, from mortgages and auto loans to business investments.
The Fed’s rate increase is considered a moderate move, and Republican critics have maintained the Fed’s rate hike is too little too late. Rate hikes also tend to operate with a lag. Larry Summers, treasury secretary under President Bill Clinton, warned in a Washington Post column Tuesday that the rate hike was not enough and would lead to stagflation and recession.
“I believe the Fed has not internalized the magnitude of its errors over the past year, is operating with an inappropriate and dangerous framework, and needs to take far stronger action to support price stability than appears likely,” wrote Summers, who also was an economic adviser to President Barack Obama and is credited with forecasting soaring inflation as a problem for the economy a year ago.
During the news conference, Powell said he expected inflation to remain high through the middle of this year, then drop, followed by a sharper fall next year. But that prediction depends on Russia’s invasion, coronavirus lockdowns in China and how the U.S. economy absorbs shocks from abroad.
Powell said that supply chains could take a further beating from the war in Ukraine and that the economy is already seeing pressure caused by higher energy and oil prices, complicating the Fed’s job.
“Making appropriate monetary policy in this environment requires a recognition that the economy often evolves in unexpected ways,” Powell said. “We will strive to avoid adding uncertainty to what is already an extraordinary uncertain moment.”
The Fed’s tools are limited when it comes to lowering prices. Monetary policy is not intended to respond to short-term blips in the economy, such as an energy shock. Yet, such shocks have the potential to weigh on the economy, especially the longer they last, forcing the Fed to consider more-aggressive moves in coming rate hikes.
To address surging energy prices, the White House, for its part, has explored a third release from the Strategic Petroleum Reserve and is considering a pause of the federal gas tax. The administration is also warning oil and gas companies not to keep prices artificially high for American consumers.
“If gas retailers’ costs are going down, they need to immediately pass those savings on to consumers,” White House press secretary Jen Psaki told reporters Wednesday. “The invasion of Ukraine and the volatility in the oil market is no excuse for excessive price increases, profit-padding or any effort to exploit American consumers.”
Inflation has cast a shadow over the recovery. Early looks at consumer sentiment in March showed it had fallen to its lowest level since 2011, according to University of Michigan survey data, as incomes took a beating from rising fuel prices. Consumers said they held very negative prospects for the economy, apart from the job market.
Powell stressed the economy’s overall strength, especially in the job market. The unemployment rate in February fell to 3.8 percent, capping off 10 straight months of strong job growth. The Fed is projecting the unemployment rate to fall to the pre-pandemic level of 3.5 percent by the end of the year.
Yet Powell also that warned the job market continues to be tight, with job openings outnumbering job seekers, which works as a drag on employers competing for workers.
“Take a look at today’s labor market. What you have is 1.7-plus job openings for every unemployed person,” Powell said. “So that’s a very, very tight labor market — tight to an unhealthy level, I would say.”
But Powell dismissed fears that a recession in the next yea had become more likely, pointing to strong household balance sheets and consumer demand that has stayed strong even as inflation has risen. That is the main reason Fed officials felt comfortable pulling back on economic supports.
In recent weeks, some economists have taken the opposite view. Goldman Sachs analysts have forecast that the economic fallout of Russia’s invasion will pull back on economic growth and raise the risk of the United States entering a recession. Gas prices have climbed to record highs, with fears that the war in Ukraine and sanctions against Russia will continue to strain global energy markets and nudge prices up.
Powell has consistently left the door open for the Fed to move more aggressively if inflation does not fall as interest rates rise, supply chains heal and congressional aid from last year fades away. But the Fed’s track record on predicting and managing inflation has come under a blistering review.
For much of the past year, Fed officials have said inflation would be a temporary feature of the recovery and limited to parts of the economy hit hardest by the pandemic. Over time, as higher costs spread to rent, groceries and everything in between, that message contrasted with what was actually unfolding in the economy and in people’s lives.
That is especially the case for families scraping by to cover the basics and for whom rent, groceries and gas make up a huge share of daily costs. Inflation has hit lower-income workers harder, even though they have seen some of the fastest wage growth during the pandemic. Those gains are being eroded by rising prices. Meanwhile, wealthier Americans have stronger protections against rising prices and can cushion inflation’s bite by dipping into savings, tapping home equity or cutting extra spending.
Douglas Holtz-Eakin, a GOP policy analyst who has served as director of the nonpartisan Congressional Budget Office, said here was “no question” that the Fed had fallen “way behind” on controlling inflation. But he credited the Fed for not having a “jumpy reaction” to Russia’s invasion and focusing on the reality of high inflation that is already baked into the economy.
“Powell is sending the message that: ‘Look, we have a plan. We will adjust it according to the data,’” Holtz-Eakin said. “That allows them to move more aggressively later, and in my view they’ll need to.”
Powell also said the Fed would announce plans to start scaling back its enormous $9 trillion balance sheet possibly as soon as May. While the Fed’s primary way of combating inflation is by raising interest rates, Powell noted that drawing down the Fed’s balance sheet could add momentum to the Fed’s seven planned rate hikes and act as a powerful substitute in place of another increase.
One Fed official, St. Louis Fed President Jim Bullard, wanted the central bank to act more aggressively and voted against the modest increase. In February, Bullard publicly called for the Fed to increase rates by 0.50 percentage points for its first hike, to make more headway on bringing prices down by the summer.
Abha Bhattarai and Andrew Van Dam contributed to this report.
correction
Due to an editing error, an earlier version of this story incorrectly stated that Larry Summers was treasury secretary during the Obama administration. He served as treasury secretary during the Clinton administration.