Written by Tess Britton
One of the most talked about economic issues of 2021 is the discussion of interest rates and Federal Reserve asset buying in relation to the current inflationary period.[1] The Federal Reserve met in late September to discuss combating inflation through tapering bond purchases. In order to stimulate the economy with pandemic-related job losses, the Fed enacted expansionary monetary policy in the form of bond buying. Currently, the Fed has roughly $120 million in monthly bond purchases.[2] With inflation running hot, many are quick to criticize these decisions made by the Fed.
It is important to discuss why inflation is so high right now in the first place. Primarily, this inflation that is being seen in the markets is a result of shortages and supply chain bottlenecks.[3] More specifically, producers are, in light of the pandemic, having a hard time keeping up with consumer demand. Production is not efficient enough to meet the high demand, therefore causing prices to rise in the economy. We can see the three major measures of inflation and see how this year compares to prior years.
Evidently, inflation is running higher than it ever has in history. To combat inflation, the central bank must increase interest rates or decrease the money supply. By increasing interest rates, the costs of borrowing are higher and thus consumers are disincentivized to take out loans. Similarly, increasing interest rates reduces the money supply because higher interest rates incentivize investors to invest in government bond buying, therefore reducing the supply of money circulating the economy. As a result, less spending leads to lower prices and thus lower inflation. These are the two biggest discussions of the Federal Reserve Bank this year during their monthly meetings. So, why haven’t they done anything about this rising inflation?
Essentially, the Federal Reserve wants to see the economy functioning as it did before COVID 19. As a result, their goal is to continue to stimulate the economy which means increasing the money supply in the economy by buying bonds.
Despite pushes from investors for the FOMC – the Federal Reserve Branch responsible for monetary policy – to start tapering bond buying, the Fed made the announcement to not make any changes once again in order to continue to stimulate economic growth in the last continuing stretches of this pandemic.
Jerome Powell, the Federal Reserve Chairman, did comment that, “if progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.” [5] Some say that this is alluding that the Fed may make the decision to begin tapering their bond buying during their November meeting.
Earlier in June, the FOMC meeting about projected federal funds rates made headline news. During this meeting, the board moved up their projections about interest rates to 2023.
A dot plot is how the FOMC members show what they believe to be the projected interest rates each year. Each dot represents one FOMC member’s projections for each period. The first dot plot displayed here is from the Federal Reserve meeting back in June. If this dot plot is compared to the September meeting, we can see that some members project interest rates to be increased as early as the end of 2022. Investors typically refer to the dot plot to have some understanding of the Fed’s projected decisions in the future so that they can make appropriate adjustments. For example, in a highly inflationary market with low interest rates, borrowing and/or taking out loans is a smart decision and it is important for investors to be aware of these changing rates.
Although we see evidence of interest rates potentially being raised near the end of 2022, “Mr. Powell has stressed in public remarks that the Fed’s decision about when to slow its bond buying shouldn’t fuel inferences about officials’ intentions to lift rates.”[8] In other words, Jerome Powell is stating that although slowing down their asset buying means they may be able to adjust interest rates sooner, investors shouldn’t be so quick to assume that these interest rates will rise right away as tapering begins.[9] The Fed does not plan to raise interest rates any time soon, focusing instead on stimulating the economy to combat current problems with supply chain bottlenecks.[10]
[1] Weller, Matt (2021). FOMC meeting recap: Powell projects a November taper announcement. City Index
[2] Cox, J. (2021). Fed Chair Powell calls inflation ‘frustrating’ and sees it running into next year. CNBC
[3] Douglas, J & Omeokwe, A. (2021). U.S. and European Economies Slowed by Delta Variant, Supply Chain Bottlenecks. The Wall Street Journal
[4] Shedlock, M. (2021). Three measures of inflation are all running hot. FXStreet
[5] Weller, Matt (2021). FOMC meeting recap: Powell projects a November taper announcement. City Index
[6] Caronello, S. (2021). The Fed’s New Dot Plot After Its June Policy Meeting. Bloomberg.
[7] Caronello, S. (2021). The Fed’s New Dot Plot After Its June Policy Meeting. Bloomberg.
[8] Timiraos, N. (2021). Powell Says Fed Could Start Scaling Back Stimulus This Year. The Wall Street Journal.
[9] Cox, J. (2021). Fed Chair Powell calls inflation ‘frustrating’ and sees it running into next year. CNBC
[10]Halaschak, Z. (2021). Yellen says ’supply bottlenecks’ will mean higher prices for at least several months. The Washington Examiner.