Federal Reserve sorts for the end of crisis policy
The Federal Reserve may begin phasing out emergency policies designed to help the economy through the coronavirus pandemic as early as this year. This is evident from a speech Friday at the annual Jackson Hole monetary symposium, held online this year, Jerome Powell, the chairman of the Fed.
The economy is showing “substantial further progress” and that makes it logical to reduce the monthly purchase of government debt before the end of the year, he said. The central bank continues to buy up to $120 billion a month in government bonds and state-backed mortgages to lower long-term interest rates. This should boost economic activity.
The Fed’s key short-term interest rate remains very low, within a range of 0 and 0.25 percent. It’s far too early for a first rate hike, Powell said: “There’s still a lot of work to do.” Most Fed officials are still anticipating a first rate hike in 2023.
A decision on phasing out the Fed’s asset-buying program is likely to fall at the September or November board meeting. In recent weeks, a chorus of Fed board members had spoken out in favor of a faster winding down of the crisis policy, especially because of the sharp rise in inflation in the US. Inflation stood at 5.4 percent in July.
The Fed is targeting inflation of 2 percent, as an average over a longer period of time. Powell said the Fed believes the current high inflation rate is temporary, as it is being fueled by abrupt price increases in sectors that were flat during the pandemic, such as the hospitality industry.
Unemployment among African Americans and Latinos remains high
Powell’s speech was cautious. He said the Fed’s second major goal – maximum employment – is not yet within reach and pointed to the advancing Delta variant as a risk. Unemployment in the United States in July was 5.4 percent, “still far too high,” said the Fed chairman. The economic recovery is “unequal” in nature, he said. “Despite progress, unemployment continues to affect disproportionately low-paid service workers, African-Americans and Latinos.”
Powell and the Fed are clearly struggling to find the right time for the exit from monetary policy from the corona crisis. History, Powell said, doesn’t offer just one guideline. In the 1950s, central banks learned that they should not react too quickly to fluctuations in inflation, because they harm the economy and employment. The 1970s provided another lesson: it turned out that temporary inflation can suddenly turn into long-term inflation. Central banks should therefore not remain passive for too long if inflation rises. All the Fed can do in 2021, Powell said, is to pay close attention to data and risk.
If the Fed does indeed start reducing its debt purchases this year, it could increase pressure on the European Central Bank to also ease its crisis policy. The ECB buys a total of around EUR 100 billion worth of government and corporate bonds every month. 80 billion of this consists of ‘pandemic emergency buyouts’, the rest of regular buyouts. The emergency buyouts will last until March 2022. Investors assume that the emergency buyouts, when they expire, will partly be replaced by regular buyouts.