The Federal Reserve is caught in a delicate balancing act as it tries to steer the country out of an unprecedented pandemic.
On one side, the Fed feels the economy still needs help given that the U.S. has yet to recover nearly 5 million jobs that were lost during the pandemic.
But the Fed is also facing another opposing problem: Inflation has climbed to its highest level in three decades as Americans have gone on a spending spree that has sparked widespread shortages.
For now the Fed is straddling a middle line as it navigates the uneven economic recovery.
At their meeting on Wednesday, Fed policymakers left interest rates near zero as part of a long-term strategy to get the country back to full employment.
But the central bank also announced a plan to start winding down another effort it undertook to help the economy through the pandemic: its purchases of at least $120 billion worth of bonds each month.
That policy was designed to help keep borrowing costs across the economy low, since bond markets help determine the rates consumers pay for auto loans and home mortgages. The Fed is expected to phase out the bond purchases by the middle of next year, although that pace could change if economic conditions warrant.
The tapering of bond purchases was telegraphed well in advance and investors took the news in stride. All of the major stock indexes climbed to new record highs on Wednesday, with the S&P 500 index rising 0.65%.
Will the Fed's plan work?
Whether the Fed can successfully straddle that middle line is uncertain given that inflation has proved to be more stubborn than many forecasters expected.
Consumer prices, as measured by the Fed's preferred yardstick, were 4.4% higher in September than they were a year ago. That's the highest annual inflation since 1991 and more than double the Fed's long-term target of 2%.
Federal Reserve chairman Jerome Powell acknowledged the hardship that persistently higher prices can cause.
"Particularly people who are living paycheck-to-paycheck are seeing higher grocery costs, higher gasoline costs, when the winter comes higher heating costs for their homes," Powell told reporters. "We understand completely what they're going through and we will use our tools over time to make sure that that doesn't become a permanent feature of life."
But Powell argued that it's premature to employ the Fed's primary tool for fighting inflation: higher interest rates.
"We want to see the labor market heal further," he said.
Powell and others have argued that upward pressure on prices is largely the result of temporary factors tied to the pandemic, which should ease on their own over time.
Powell acknowledged, however, that supply-chain bottlenecks and the resulting high inflation are likely to persist well into next year. Fed policymakers also added a note of caution in their official statement Wednesday. Whereas inflationary forces were simply described as "transitory" in the past, they are now "expected to be transitory."
The problem is that while prices for some commodities have fallen in recent months, many supply chain bottlenecks have persisted, and in some cases gotten worse.
A survey of U.S. factory managers last month found many struggling to find parts and raw material — and enough workers — to keep pace with booming demand. Faced with higher costs on all fronts, one furniture factory said it was considering its third price increase this year.
Workers' pay is also rising, though not as fast as prices. On average, wages and salaries in September were 4.2% higher than a year ago.
Powell said he and his colleagues are on the lookout for the kind of wage-price spiral that led to runaway inflation in the 1970s, but he doesn't see evidence of that so far. If it were to materialize, Powell has said, the central bank is prepared to raise interest rates.
The Fed faces plenty of inflation critics
Some economists — including Lawrence Summers, who served in the Obama and Clinton administrations — warn that the Fed is underestimating the danger of inflation. They worry that failure to restrain prices now could force a more painful crackdown later.
Powell, however, is sticking to his cautious timetable.
The country was enjoying a low unemployment rate and a healthy job market, but the path back has been rocky. Many employers are eager to hire, but after adding about a million jobs in both June and July, job gains slowed sharply in August and September.
"We were on a path to a very different place," Powell said. "Delta put us on a different path."
There were 3 million fewer people working or looking for work in September than there were before the pandemic. Some people retired. Others were busy caring for children or worried about catching COVID-19.
Getting back the missing workers
Now that schools have reopened and the health outlook is improving, the Fed is counting on many of those people to rejoin the workforce, relaxing pressure on both wages and prices.
That's not a sure thing, though. And the longer it takes for the workforce to rebound, the more inflationary heat the Fed may be feeling.
"I think the biggest question out there right now is where are all these missing workers?" asked Nela Richardson, chief economist at the payroll processing company ADP. "How long will they stay missing? And what will entice them to come back into the labor market?"
For now, the Fed is willing to tolerate a period of higher inflation in an effort to promote full employment.
But if the central bank concludes that the pandemic has permanently lowered the bar of what full employment looks like, the Fed's balancing act could shift toward a faster increase in interest rates and a tougher crackdown on inflation.
Powell acknowledged the challenge of steering the economy through uncertainty conditions.
"What it really boils down to is something that is common sense and that is risk management," he said. "We have to be humble about what we know about this economy, which is still very COVID-affected."
AUDIE CORNISH, HOST:
The Federal Reserve is leaving interest rates at rock bottom levels even though inflation is running much hotter than the central bank would ordinarily like. Consumer prices in September, as measured by the Fed's preferred yardstick, were up nearly 4.5% from a year ago, and that's the sharpest increase in three decades. Now, the Fed still believes those price hikes will settle down once the pandemic passes, although inflation has already stayed higher for longer than many forecasters expected.
NPR's Scott Horsley has been following the Fed's announcement, and he joins us now. Welcome back, Scott.
SCOTT HORSLEY, BYLINE: Hi. Good to be with you, Audie.
CORNISH: So you were following the Fed's announcement today, right? The Fed is still describing this high inflation as a temporary byproduct of the pandemic. What more did they have to say?
HORSLEY: Well, the Fed added some language to its formal statement today, spelling out what it thinks is behind this high inflation. Basically, Americans are buying a ton of stuff, but pandemic-related bottlenecks are making it hard for businesses to keep up with that demand. Now, the central bank doesn't think that imbalance is going to last forever, but it does say the bottlenecks and the resulting high inflation are likely to last well into next year. And of course, the longer inflation stays high, the more it eats into people's pocketbooks. Fed Chairman Jerome Powell took pains to say today he gets that.
(SOUNDBITE OF ARCHIVED RECORDING)
JEROME POWELL: Particularly people who are living paycheck to paycheck or seeing higher grocery costs, higher gasoline costs, when the winter comes, higher heating costs for their homes, we understand completely what they're going through. And, you know, we will use our tools over time to make sure that that doesn't become a permanent feature of life.
HORSLEY: If it looked like inflation was in danger of becoming permanent, the Fed would raise interest rates. But Powell and his colleagues don't want to do that just yet.
CORNISH: Well, what are the signals that they're looking for or waiting for?
HORSLEY: Well, the thing is, raising rates wouldn't necessarily fix the root cause of this inflation. It wouldn't unpack those cargo ships in the West Coast ports any faster. It wouldn't produce any more computer chips for the automakers. But it would potentially put the brakes on job growth. And Powell and his colleagues at the Fed are reluctant to do that when there are still millions of people out of work.
(SOUNDBITE OF ARCHIVED RECORDING)
POWELL: We don't think it's time yet to raise interest rates. There is still ground to cover to reach maximum employment, both in terms of employment and in terms of participation.
HORSLEY: The Fed did express a vote of confidence in the economy, though, today. It announced plans to start phasing out the big bond-buying program that it launched in the early days of the pandemic in an effort to prop up the economy. Financial markets were well primed for that announcement. It was widely telegraphed, and investors seemed to take the news in stride.
CORNISH: Scott, on another subject, I know the Fed also addressed this controversy over trading activity of a couple of regional Fed bank presidents. What is it doing?
HORSLEY: That's right. The presidents of both the Dallas and Boston Fed banks stepped down under pressure last month after reports that they had been actively trading stocks and other securities last year at a time when the central bank was deeply involved in the financial markets. Since then, the Fed has imposed some stricter rules about the kinds of investments that senior staff can buy or hold and the kind of disclosures and approvals they have to go through. This new rule is designed to avoid any appearance of a conflict of interest.
(SOUNDBITE OF ARCHIVED RECORDING)
POWELL: We need to have the complete trust of the American people that we're working in their interest all the time - absolutely critical to our work as it is for any government agency. And I feel like this called that into question, so we reacted, I would characterize it, strongly and forcefully.
HORSLEY: And Powell said he discussed these moves with both the administration and members of Congress. We should say this all comes at a sensitive time for Powell. His term as Fed chairman expires in just a few months, and we are awaiting word on whether he's going to be renominated.
CORNISH: That's NPR's Scott Horsley. Scott, thank you.
HORSLEY: You're welcome. Transcript provided by NPR, Copyright NPR.