The 13 days that made Fed chief pivot on inflation

NEW YORK • Inflation in the US has been building for months. But it was over 13 days this autumn that Federal Reserve chairman Jerome Powell decided the central bank needed to get more serious about trying to choke it off.

The story of Mr Powell's latest pivot - the abrupt move towards tighter monetary policy announced on Wednesday - shows a great deal about the decision-making approach of the man whom President Joe Biden has nominated for a second term as the United States' top central banker.

In short: He may stick to his chosen policy path in the face of public pressure as long as evidence does not undermine his assumptions, but he is willing to change course quickly when data suggests the world is different.

The Fed on Wednesday said it will double the pace at which it is scaling back purchases of Treasuries and mortgage-backed securities to US$30 billion (S$41 billion) a month, putting it on track to conclude the programme early next year, rather than mid-year as initially planned.

Mr Powell told a post-meeting press conference that the faster taper puts the programme on track to end in mid-March and that officials expect "a gradual rate of policy firming". He said officials do not expect to raise rates before ending the scaling back of bond buying, but could hike them before reaching full employment.

Projections published alongside the statement showed officials expect that three quarter-point increases in the benchmark federal funds rate will be appropriate next year, after holding borrowing costs near zero since March last year.

The mantra of Fed officials throughout the summer that inflation was likely to be transitory is now, officially, history.

More than usual in a Fed news conference, Mr Powell narrated the events that caused his policy pivot. Complaints about high inflation have been surging since the spring, but Mr Powell and the Fed stuck to their view that it would fade and that they needed to move gingerly in pulling back on stimulative policies. That started to change with a piece of economic data - on Oct 29 - that is closely followed by economists but gets relatively few headlines: a surge in the employment cost index.

That surprisingly high number suggested that employers' spending on wages and benefits was rising faster in the summer than economists had thought. It put Mr Powell on alert that inflationary pressures had the potential to be broader and longer lasting than the Fed had been expecting.

That, he said, made him consider adjusting plans for a Fed policy meeting five days later to wind down the bond-buying programme faster than analysts expected.

He and his colleagues on the Federal Open Market Committee instead stuck to the plan, but two more data points in the ensuing days were making clear that inflation risks were building.

First, on Nov 5, a robust employment report showed strong job creation and a rapidly falling jobless rate. Then, on Nov 10, the US consumer price index showed a surge in inflation. That was enough for Mr Powell. As colleagues began giving speeches in the following days, they made clear that a more hawkish approach to monetary policy was in the offing, which Mr Powell affirmed last week.

"I think that the data we got towards the end of the fall was a really strong signal that inflation is more persistent and higher, and that the risk of it remaining higher for longer has grown," he said in the news conference. "And I think we are reacting to that now."

The constellation of evidence that emerged from those three data points from Oct 29 to Nov 10 - since confirmed by other data releases - suggested that an inflation problem that once seemed mainly confined to cars, airfare and a handful of other products had become more broad-based.

And as employers pay more in wages and other costs to keep their workers, the possibility that they simply pass on those expenses to customers in a self-reinforcing cycle of higher pay and higher prices has become more real. This wage-price spiral was a feature of the sustained high inflation that lasted from the late 1960s to the early 1980s.

Central bankers always face a tension between under-reacting and overreacting to the latest economic headlines. If they react too fast to incoming information, policy can become erratic, creating unnecessary market volatility and failing to see through temporary forces that buffet the economy.

But if they react slowly, it can create a risk of becoming out of step with the realities of the economy. Historical examples include when the European Central Bank raised interest rates in 2008 even as what would become the global financial crisis was starting to drag down the European economy.

In the worst case, it could drive the economy to bad results out of some mix of stubbornness, ego and a refusal to admit a mistake.

Mr Powell's strategy has been to set out a forecast of how Fed leaders believe the economy is likely to evolve and stick to his guns, but be ready to change course abruptly if the evidence becomes compelling that the forecast was wrong.

That is also the pattern seen in his earlier pivot, in late 2018 and early 2019, although that was a shift in the opposite direction from this one. The Fed hiked rates four times in 2018, earning withering public attacks from then President Donald Trump. And at its December 2018 meeting, almost all Fed officials saw multiple additional rate hikes over the course of 2019 to head off inflation.

In the days that followed, markets plunged and bond and other markets suggested the Fed had made a mistake - that the economy was not in position to withstand those rate increases. Mr Powell abruptly changed tone in January 2019, and by the middle of the year was cutting rates.

As senators weigh whether to confirm him for a second term, they will ultimately be judging whether the Powell pivots, especially this most recent one, have been too fast, too slow, or just about right.

NYTIMES