In June of last year, Jerome Powell, the chair of the Federal Reserve, held a two-day policy meeting with his top colleagues. The first COVID-19 wave was winding down, and some businesses were starting to reopen after the closures enacted at the onset of the pandemic. But the unemployment rate was still at 13.3 per cent, and during the previous three months nearly twenty million workers had lost their jobs or been furloughed. Powell and other members of the Fed’s main policymaking committee thought that the recovery would be a long, slow grind. Their median forecast was that the unemployment rate would be 6.5 per cent in the fourth quarter of 2021, and in the fourth quarter of 2022 it would be 5.5 per cent.
How did these predictions turn out? On Friday, the Labor Department reported that the unemployment rate had fallen to 4.2 per cent in November. The jobless rate isn’t just considerably lower than Powell and his colleagues predicted; it’s already well below where they thought it would be a year from now. And all indications suggest that there are still a great number of positions waiting to be filled. On the last day of September, the latest date for which the Labor Department has released figures, there were 10.4 million vacancies across the country, close to record levels. With job openings plentiful, the number of people filing new unemployment claims has fallen sharply. A couple of weeks ago, it hit the lowest level since 1969: a hundred and ninety-nine thousand. Last week’s figure was a bit higher, but not much.
This is good news for America’s workers, who finally have a bit of leverage over employers. It also suggests that the Fed’s decision, early in the pandemic, to cut short-term interest rates to zero and pump more than a hundred billion dollars of freshly minted dollars into the bond markets every month has succeeded in getting the economy through some very dark times. But the economy’s resilience during the pandemic has also left Powell in an awkward position. At the meeting in June, 2020, he and his colleagues predicted that the rate of inflation would now be less than two per cent. In the twelve months to October, the Consumer Price Index rose 6.2 per cent, the highest jump since 1990.
For months, some observers, including Lawrence Summers, the former Treasury Secretary, have been accusing the Fed of reacting too passively to an upturn in inflation and warning of a possible wage-price spiral. Meanwhile, Republicans have been blaming Joe Biden for higher prices, even though his policies have had very little to do with them.
After long brushing off critics and arguing that the inflation spike was a “transitory” product of supply disruptions in certain parts of the economy, Powell abruptly changed his tone last week. Though conceding that the Omicron variant poses “downside risks” to employment and spending, he told the Senate Banking Committee that “the economy is very strong and inflationary pressures are high.” He also said that it was “probably a good time to retire” the word “transitory.” The Fed’s boss and his colleagues are set to gather next week for their final meeting of 2021. Powell said that it would be “appropriate” for them to discuss taking a further step toward withdrawing some of the monetary stimulus that they have been applying to—in Fed jargon—“accelerate the taper.” Such a move could prepare the way for interest-rate hikes in 2022.
A cynical observer might suspect that Powell waited until Biden had nominated him for a second term—a decision the President announced just prior to Thanksgiving—before sounding the warning on inflation and a possible tightening in Fed policy. Whether that’s true or not, the sixty-eight-year-old former private-equity executive is now facing the toughest challenge any Fed chair can confront: trying to change policy direction and engineer a soft landing for the economy without precipitating a financial crash or a recession. Two of his three predecessors—Alan Greenspan and Ben Bernanke—failed spectacularly to pull off this feat. On Monday morning, the Dow jumped by six hundred points, indicating that investors aren’t overly worried about a repeat performance. But, with the market trading at extraordinarily high levels, a break on Wall Street could easily feed on itself. And, of course, Powell has also got Omicron to worry about.
The new variant, which has now been confirmed in at least seventeen states, has created a great deal of uncertainty about the economic outlook. This past summer, after the Delta variant hit, both job growth and G.D.P. growth slowed sharply for a time. If Omicron proves more virulent than Delta, it could have even bigger effects on the economy, although a return to widespread shutdowns seems unlikely at this stage. Some Fed officials are also concerned that the new variant may exacerbate global supply-chain disruptions, fuelling further price rises for items that are already hard to find. The risk is that Omicron could “increase those inflationary pressures, in those areas that are in high demand,” John C. Williams, the president of the New York Fed and the vice-chair of the Federal Open Market Committee, told the Times last week.
Given all these crosscurrents, it seems like it might make sense for the central bank to keep its options open. One longtime Fed watcher I spoke with said that was what Powell was doing last week by making his hawkish comments about inflation and accelerating the taper. “By tapering early, the Fed can actually increase its optionality going into 2022,” Tim Duy, the chief U.S. economist at SGH Macro Advisors, said. “They could decide to raise interest rates as early as March, or, depending on the incoming data, they could continue to push out until the fall.”
Duy also said that he suspects, with core inflation running at more than four per cent and the jobless rate at 4.2 per cent, many people at the Fed believe that the necessary conditions for a rate hike have already been met. But Powell has committed to a data-dependent approach, and Omicron will certainly affect the incoming data. So far, its impact has been deflationary. In the past couple of weeks, the price of crude oil has fallen by more than ten dollars a barrel—which should feed through to cheaper gasoline in the weeks ahead. That could be an argument for why the Fed has been sitting on its hands a bit longer, gathering more information, and waiting until its policy meeting in January before taking any action.
On the other hand, this Thursday the Labor Department will release the Consumer Price Index for November, and it could show another jump in the inflation rate, which would increase the pressure on Powell to act. During his first term as Fed chair, he had to deal with Donald Trump as the President and the onset of a deadly global pandemic. His second term may well turn out to be an even bigger challenge.