Federal Reserve Chairman Jerome Powell sent “three significant messages” on the economic outlook in his address last month in Jackson Hole, Wyoming, according to Christina Skinner, Wharton professor of legal studies in business ethics. Hosted by the Federal Reserve Bank of Kansas City, the annual Jackson Hole symposium is keenly tracked for economic policy pointers.
The first takeaway from Powell’s speech is that the Fed sees the current inflation rate above its target range of 2% as a temporary phenomenon, Skinner said on the Wharton Business Daily show on SiriusXM (Listen to the podcast above). Her second takeaway is that the Fed will start pulling back from some of its crisis-era interventions; specifically, it will likely slow the pace of asset purchases, she added. The third message is that the Fed isn’t planning to raise its benchmark interest rate anytime soon, she noted.
Of those, “the most significant policy decision” is that “the Fed is now clearly committing to an intent to start exiting from QE (quantitative easing),” Skinner said. “An intent to commit to something like this might seem very attenuated, but in Fed speak, it’s quite a significant statement.”
In QE, the Fed buys treasury and mortgage-backed securities, which has the effect of reducing long-term interest rates and making business and mortgage borrowing cheaper, as a Brookings explainer noted. In response to the pandemic, the Fed in March 2020 cut short-term interest rates to zero and began asset purchases totaling $120 billion each month. As the economy rebounded in mid-2021, Fed officials began talking of a “tapering” of the QE or slowing down asset purchases. As of September 6, 2021, the size of the Fed’s assets approached $8.4 trillion, which was nearly double of that in March 2020.
“It would have been unusual for the Fed to have both raised rates and backed down from asset purchases.” –Christina Skinner
Delinking Interest Rates from Asset Purchases
The Fed’s plan to put off raising interest rates “makes sense,” Skinner said. “It would have been unusual for the Fed to have both raised rates and backed down from asset purchases. It was probably always going to be one or the other, once we hit recovery mode, with the question of sequencing — which one was going to come first.”
Indeed, Powell had unambiguously delinked the two in his Jackson Hole speech. “The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test,” he had said.
The Fed will have thought “very long and hard” before committing its intention to start scaling back from some of its emergency or crisis fighting measures, starting with asset purchases, Skinner noted. “There’s a pretty high bar at this point from diverting course.”
Tracking Job Growth and Price Stability
The pointers from Powell have to be viewed against the backdrop of the Fed’s monetary policy goal of achieving maximum employment and price stability. Skinner said she gleaned from Powell’s speech a “signaling [that] we’re already there,” and that it sees the recent departures from that course as transitory. “The message is that employment and growth — or general recovery — is also heading in the right direction, notwithstanding maybe some bumps along the way.”
The annual inflation rate rose 5.3% in August 2021, on the back of a 5.4% increase in both July and June 2021. Powell had noted in his speech that while “central banks cannot take for granted that inflation due to transitory factors will fade,” it would be unwise to rush to respond to temporary fluctuations in inflation.
“The main influence of monetary policy on inflation can come after a lag of a year or more,” Powell had pointed out. “If a central bank tightens policy in response to factors that turn out to be temporary, the main policy effects are likely to arrive after the need has passed. The ill-timed policy move unnecessarily slows hiring and other economic activity and pushes inflation lower than desired.”
At the same time, “it’s important for the Fed to keep trying to anchor expectations that the inflation that we’re seeing is transitory,” Skinner said. “Once inflation slips past a certain point, whether that’s 5%, 6% or 7%, it can be very difficult to stop inflation from climbing into double digits.”
On employment, Powell observed that the outlook for the labor market has “brightened considerably” in recent months. Job gains have risen steadily over the course of this year and now average 832,000 over the past three months, and the pace of total hiring is faster than at any time in the recorded data before the pandemic, he had said.
“Once inflation slips past a certain point, whether that’s 5%, 6% or 7%, it can be very difficult to stop inflation from climbing into double digits.” –Christina Skinner
But he also pointed out that “the unemployment rate … is still much too high,” even as it reached a post-pandemic low of 5.4% in July 2021; it declined further to 5.2% in August 2021. “The message [from the latest unemployment report] is still that we were heading in a good direction,” Skinner said. “The Fed will remain optimistic until it has more reason to think otherwise.”
Powell shared that positive employment outlook in his speech. “While the delta variant presents a near-term risk, the prospects are good for continued progress toward maximum employment,” he had said. He expected more people to be looking for jobs with the increasing pace of vaccinations, schools reopening, and the expiration of enhanced unemployment benefits.
Focus on Uneven Impacts
Powell also went granular on the unevenness of the recovery, noting that “as the pandemic struck, restaurant meals fell 45%, air travel 95%, and dentist visits 65%.” He added that the unevenness is borne out by the shift in recent consumer spending, away from in-person services such as travel and leisure in favor of durable goods such as appliances, furniture, and cars. He brought up other inequalities as well: “Despite progress, joblessness continues to fall disproportionately on lower-wage workers in the service sector and on African Americans and Hispanics,” he said.
“The Fed has made a real effort to be mindful and communicate about what’s happening in the real economy,” Skinner noted. “This is probably one reason why the Fed has chosen to slow asset purchases before raising rates. The Fed is of the view that raising rates prematurely can be worse for lower wage-earning groups.”
QE, too, “is not that helpful for inequality,” Skinner said. “QE tends to benefit asset holders and can hurt wage earners to the extent inflation comes along with sustained, prolonged asset purchases.” The Fed is thinking about scaling back asset purchases also because “it needs headroom to fight the next crisis,” she added. “It just can’t be in a position where it’s out of ammo for next time.”
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