The High Inflation And A Surging Virus Dilemma

As COVID-19 cases accelerated across the country, the decision about when and how the Fed should reduce its support for the economy became more difficult, a report said.

Federal Reserve Chair Jerome Powell‘s Friday speech, in which he outlined his views on the economy and the dangers it faces, may offer important clues as to when the Fed will change its ultra-low interest rate policies.

The question is when the Fed will stop buying Treasury and mortgage bonds. Since March 2020’s pandemic, the Fed has been purchasing $120 billion worth of bonds every month to help keep long-term rates low and encourage spending. Since then, the Fed has kept its benchmark short-term interest rate close to zero.

Powell will speak Friday at the annual conference of academics and central bankers. For the second consecutive year, the conference sponsored by the Federal Reserve Bank of Kansas City will be held online only. The Fed was forced to cancel its in-person plans due to a surge of COVID-19-related cases close by the Wyoming resort.

Just a few weeks ago, many Fed officials were signaling that the economy was making solid progress toward the central bank’s twin goals of maximum employment and annual inflation at just above 2% for a sustained period. Several presidents of regional Federal Reserve Banks said they wanted to announce a reduction, or taper, of the bond purchases at the Fed’s next meeting in September.

However, economists are reducing their expectations for economic growth during the current quarter of July-September. Restaurant traffic has dropped slightly. Last week, Powell said it wasn’t yet clear what the delta strain’s impact on the economy would be. He stressed that the pandemic was not over and was still “casting shadows on economic activity.”

Economists will be watching closely for clues Powell might provide about Fed’s intentions, as the economic picture is getting worse.

Economists believe it is more likely that the Fed will announce tapering in November, or later, due to the uncertainties caused by the delta variant. This would allow Fed officials two more months of data on inflation, jobs, and the impact of the delta variant.

Fed’s problems are not limited to the resurgence virus. Inflation has jumped 3.5% in June compared with a year earlier, the biggest such rise since 1991.

Inflation has increased pressure on Powell, Fed, and other central banks to reduce their stimulus programs. Powell has maintained his confidence that higher inflation would be temporary, even though it may persist for several months. Many Wall Street investors and economists agree. Some are actually more worried about the opposite problem: that inflation will fall too far below its current level.

Nevertheless, growth may slow. Next year, government stimulus will fade. There are no more government stimulus checks in the works, and a federal unemployment supplement of $300 per week is due to expire in just two weeks. Gaske pointed out that consumers have been reducing their spending on furniture and cars due to price increases, which in turn has reduced inflation pressures.

Inflation could be pulled below its target of 2% by any Fed policy change. This could happen in as little as a year.

Officials at the Fed expected more clarity about the economy and the job market in the early fall. As the pandemic receded, more Americans would go back to work instead of being afraid of the virus. The Fed could delay the moment when it can see the state of the labor market, as the fear of the delta variant could continue, the report said.