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Challenge to Fed Commitment

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The Federal Open Market Committee (FOMC) will meet June 15-16. The FOMC will upgrade its assessments of inflation and growth in the official statement and the quarterly forecasts. Both inflation and economic growth have come in stronger than forecast. The number of committee members now expecting rate hikes in 2023 is expected to rise by at least one; the majority of participants expects rate hikes in 2024 or later. Higher inflation will test the Federal Reserve’s commitment to allowing employment to catch up because employment tends to be a lagging indicator.

Fed Chairman Jay Powell will continue to stress that he believes the current rise in inflation is transitory. He will get pushback from reporters citing reports of labor shortages and the pickup in wages for low-wage workers. Powell will cite the hurdles to bringing back sidelined workers after a year of inactivity due to the pandemic. Large employers who have advertised wage hikes have seen a surge in applications, while small businesses who can’t compete are doing without. These shifts should be transitory.

Productivity growth is increasing, which should curb the pass-through of wage gains to prices. Many high-contact jobs that existed prior to the crisis, like taking tickets, have been eliminated entirely. Fast-food restaurants are trying to automate order and payment for their drive-throughs. This is at the same time that a broad shift to shopping online (which was accelerated by the crisis) should intensify comparison shopping and drag on prices after disruptions to the supply chain have been resolved.

At the end of the day, Powell will argue that it is better for the FOMC to risk overshooting than undershooting on inflation, given the solid but not spectacular pace of job gains. The central bank is better equipped to cool an overheating economy with rate hikes than to revive an economy that chills before it has recouped employment lost to the crisis.

It should be noted that Powell has made his views known about where the balance of power remains in the economy; that is among more affluent households. He has embraced an economy that he believes can deliver more to the bottom 20% than in the past. He has a history in business, knowing that what employers say about the labor market represents only a portion of a much more complex narrative.

Powell will also be asked when the Fed will consider tapering its monthly purchases of $80 billion in Treasury bonds and $40 billion in mortgage-backed securities. Debate over the timing of tapering is expected to intensify. Powell is expected to address tapering directly in his keynote speech at the end of August during the Kansas City Fed’s annual Jackson Hole, Wyoming meeting.

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