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Inflation may force the Federal Reserve to raise interest rates

RACHEL MARTIN, HOST:

Consumer prices are rising at a pace not seen in nearly four decades. So what can the Federal Reserve do? The Fed starts a two-day meeting today, and inflation is going to be top of mind, as it is for David Wessel. He is director of The Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution and a regular contributor to this show. Hey, David, thanks for being here.

DAVID WESSEL: Good morning, Rachel.

MARTIN: So it's been impossible to talk about the economy in any fashion without talking about COVID. Is that still the case for the Fed?

WESSEL: Well, absolutely. I mean, like everybody else, the Fed has to worry about how the COVID variant will play out, how it'll affect consumer, worker and business behavior. But as you suggest, the big issue at today's meeting is inflation, which is stubbornly running above - well above - the Fed's 2% target. So they have to ask themselves, will price pressures abate next year as COVID-related kinks in the supply chain are smoothed out and people come back to work and steep price increases in things like used cars are reversed? Or is inflation likely to persist as we have strong consumer demand continuing to press against the economy's capacity to produce and import goods and services? And then on top of that, they have to worry that all these headlines about inflation are making people increase their expectations for future inflation, which economists think can become a self-fulfilling prophecy.

MARTIN: So they raise all these questions, but isn't it sort of the Fed's job to also come up with answers?

WESSEL: Absolutely. So for the last several months, the Fed has been describing the surge in prices as, in their word, transitory. But Fed Chair Jay Powell recently said he's retiring that word, which is a significant change in tone. I think most Fed officials expect the inflation rate to come down somewhat next year, although they seem a little less certain about that than they were. But there's huge disagreements among them about how much of the recent increase inflation can be pinned to COVID and is likely to dissipate. And how much is driven by factors that are likely to persist - the fact that people have a lot of savings because of the fiscal policy because the workforce doesn't seem to be growing? And as a result, there's a lot of disagreement at the Fed about how rapidly it should lift its foot off the monetary gas pedal. And that's what they're going to talk about today and tomorrow.

MARTIN: Right. So Fed officials have kept interest rates low for a long time to help keep the economy going, boost hiring, right? So what changed?

WESSEL: Well, for a long time, the Fed talked a lot about the maximum employment side of its mandate. The Fed has two jobs Congress has assigned it - maximum employment and price stability. It was easier for them to focus on the labor market before we had the string of bad inflation reports and there was so much attention to rising prices, not only among the public but among members of Congress, union negotiators, financial markets. And then the other thing is that Fed and other economic forecasters are really surprised that so many workers are remaining on the sidelines, neither working or looking for work, at a time when there are so many job openings. And that's led some at the Fed to think that they've basically reached their maximum employment goal and have to shift to balancing it against their inflation goal.

MARTIN: So the Fed's going to make an announcement tomorrow afternoon after this meeting wraps up. What are they likely to do considering all of that?

WESSEL: Right. Well, the Fed has been holding short-term interest rates at zero since the onset of the pandemic in early 2020, and it has been buying tens of billions of long-term bonds each month to bolster the economy. It began reducing these monthly bond buying - they call it tapering - in November. Tomorrow, it's almost certain to announce that it's quickening the pace of that tapering so that the bond buying will end in March 2022. And that's important because the Fed has said it won't raise interest rates until it's done buying bonds. So what the big question for Fed watchers tomorrow is whether they'll have - whether the Fed will signal that it's going to raise rates two or three times in 2022.

MARTIN: All right. David Wessel, the director of The Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. Thanks, David.

WESSEL: You're welcome. Transcript provided by NPR, Copyright NPR.

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