Game time: The Fed unveils a tougher plan to fight stubbornly high inflation

Scott Horsley

January 26, 2022 / 11:08 am

Faced with mounting pressure from rapidly rising consumer prices, the Federal Reserve is preparing to raise interest rates sooner — and perhaps more aggressively — than had been expected just a few months ago.

The central bank is trying to prevent stubbornly high inflation from becoming a permanent feature of the economy. Prices in December were up 7% from a year earlier — the sharpest jump in nearly four decades.

At the conclusion of a two-day meeting Wednesday, Fed policymakers signaled that the labor market has neared the "maximum employment" threshold, which it has identified as a precondition for raising interest rates.

"With inflation well above 2 percent and a strong labor market, the [rate-setting] Committee expects it will soon be appropriate to raise the target range for the federal funds rate," policymakers said in a statement.

Forecasters expect the central bank to begin raising rates from their current level of near zero as early as March.

Maximum employment is a moving target. About 3.6 million fewer workers are on payrolls now than before the coronavirus pandemic.

But with job growth slowing in recent months and millions of people on the sidelines not actively looking for work, Federal Reserve Chair Jerome Powell said the central bank cannot afford to leave inflation unchecked.

"To get the kind of very strong labor market we want with high participation, it's going to take a long expansion," Powell told lawmakers this month. "And to get a long expansion, we're going to need price stability."

Why inflation is on the rise

Prices during the pandemic have been far from stable.

Consumers have spent freely, thanks in part to generous government relief payments. But with workers and supplies often scarce, many businesses have struggled to keep pace with that demand. The resulting price hikes have proved to be much more persistent than the Fed initially expected, much like the pandemic itself.

The price of new cars, for example, has jumped 12% in the last year as automakers struggle with a shortage of semiconductors. That's had a spillover effect in the used-car market, where prices have soared 37%.

The Commerce Department warned this week that it doesn't expect the semiconductor shortage to ease in the near future.

Gasoline and groceries have also gotten more expensive. Price-checkers point to elevated inflation in more than two out of three categories the government tracks. Powell, who's been nominated for a second term as Fed chair, insists the central bank will not allow that continue indefinitely.

"We know that high inflation exacts a toll, particularly for those less able to meet the higher costs of essentials like food, housing and transportation," Powell told Senators during his confirmation hearing. "We will use our tools to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched."

Raising interest rates would not solve the supply chain woes, but are intended to tamp down consumer demand.

The Fed is also pursuing other actions to fight inflation

In addition to raising interest rates, the Fed is expected to gradually begin shrinking its portfolio of government debt and mortgage-backed securities later this year. Doing so is another way to fight inflation, by pushing up long-term borrowing costs across the economy.

Mortgage rates have already risen to their highest level since the start of the pandemic, in anticipation of the central bank's moves.

Investors' concern about rising prices and the Fed's response has contributed to extreme volatility in the stock market this week.

The Fed expects inflation will cool this year, provided the public health outlook improves, easing shortages of both workers and supplies.

But Powell acknowledged that similar hopes have been dashed in the past.

"I don't think two years ago, we thought we'd still be having record levels of cases," Powell told lawmakers at the height of the omicron wave. "Getting past the pandemic is the single most important thing we can do."

Fed policymakers predicted in December that inflation would fall to around 2.6% by the end of this year, less than half its current rate. (The Fed's preferred yardstick for inflation is the Commerce Department's index of personal consumption expenditures, which was 5.7% in November.)

The central bank says it's prepared to adjust interest rates more – or less – aggressively, if actual inflation turns out to be higher or lower than forecast.