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Fed Commits to Overshoot on Inflation

RFP
The Federal Reserve Open Market Committee (FOMC) jumped into the water and actually committed to overshoot on inflation before raising rates again. The Fed was expected to hold off on its decision given the lack of consensus on how much and how long of an overshoot on inflation they would tolerate. The statement merely confirmed a desire “to moderately exceed 2% [inflation target] for some time.” Two regional Federal Reserve Bank presidents dissented on the decision. Rob Kaplan of the Dallas Fed preferred to hold to the previous statement until consensus could be reached. Neel Kashkari of the Minneapolis Fed wanted to just say the Fed would wait until it reached 2% inflation for a sustained period. The challenge for the Fed is to commit to a little inflation without signalling that it would tolerate a flare, or rapid surge, in price levels.

Risks remained to the downside for the outlook over the medium term. The Fed updated its forecasts through 2023. The contraction in 2020 is now less than expected but much of the good news may be behind us, as the pace of improvement is waning. The forecast for 2023 does not get us back to the lows on unemployment that we saw before the onset of the COVID crisis in February. The Fed expected to hold the fed funds rate at its current target through at least year-end 2023. The Fed statement on tolerating a bit of an overshoot on inflation to achieve its goals on employment is consistent with no change in the fed funds rate for years. Notable that Chairman Powell said that the Fed forecasts are predicated on more aid by Congress.

The most notable change in the forecasts among participants was a widening of the spread in their expectations on inflation for 2021. All have moved up slightly from their June assessments but at least one participant is now expecting inflation to top 2.4% by year-end 2021. That is almost a half percent higher than the 2% outlier we saw in the June set of forecasts. Also notable is the forecast for rate hikes. One participant is expecting a rate hike as soon as 2022. Four expect one or more rate hikes in 2023. This is still a minority of the 17 participants who provided forecasts for the 2020-23 outlook. One participant did not provide a long-run forecast for the June or September meetings.

The Fed committed to keep purchasing Treasury bonds and mortgage-backed securities to keep credit markets functioning. This means a continued increase in the Fed’s balance sheet. The Fed has not committed to yield-curve controls yet, but has left that door open.

Chairman Jay Powell underscored that the economy remains in a deep hole despite recent gains. He highlighted the disproportionate pain being felt by low-wage women, Black and Hispanic workers. He expressed outward concern about the recent resurgence in COVID cases and downside risks to the broader economy. He repeated his plea for more aid from Congress amidst a slowdown in the pace of the recovery. The Fed is clearly worried about how long it will take for the economy to heal and recover, which ups the urgency for more aid.

Powell directly addressed concern about lapsed supplements to unemployment insurance; it ended too soon for too many. He also said that state and local governments will need funding to fill the gap in their budgets tied to COVID. Both issues have been sticking points on Congress moving. Powell has gone full in on his support of Congressional aid, something he refused to do prior to the crisis. This time is different.

Powell went out of his way to emphasize the Fed’s concern about the individual households and communities, not just financial markets. He was plain spoken and clearly wants to communicate more directly with the public. This is still a heavy lift for the Fed but necessary. He went into the need for more inclusive growth, arguing the need for prosperity to be very broadly spread. He even acknowledged that the Fed is taking the unemployment rate of Black people specifically into account when making decisions on policy. He said that the Fed would keep policy accommodative for “as long as it takes” to bring the hardest hit workers back into the labor market.

That said, the Fed is limited in what it can do. Powell repeated his now-familiar mantra: The Fed can lend, not spend. The most officials feel they can do is to overshoot on inflation a bit and allow wages instead of profits to rise as a share of the economy down the road. That could take years. Addressing systemic bias requires legal decisions by our elected officials in Congress and at the state and local levels.

Bottom Line
The FOMC is concerned about both the course of the virus and the pace of the recovery; members see the two as intertwined. This is what makes the resurgence in COVID cases over the summer so concerning. More Congressional aid, better use of masks, testing and tracing are all needed to ensure a better recovery. The fear is that the recovery will hit a wall in the fourth and first quarters, absent such measures.

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