Fed Under Fire For Inaction On Inflation

On Wednesday, the government is expected to report that consumer prices jumped 7.1% over the past 12 months, which would be the steepest such increase in decades. Fed Chair Jerome Powell is sure to be grilled on the issue during a Senate hearing Tuesday on his nomination for a second four-year term. Inflation has become the most serious threat to the economy, a growing worry for the financial markets and a major political problem for the Biden administration and Democrats in Congress.

While Powell has many defenders who applaud the Fed's willingness to keep interest rates low to help reduce unemployment after the pandemic recession, Friday's U.S. jobs report for December raised alarms. It showed another sharp drop in the unemployment rate, an unexpectedly large increase in hourly pay and chronic labor shortages.

Though lower joblessness and higher pay benefit workers, they can also fuel rising prices.

The jobs report led many economists to forecast more interest rate hikes this year than they had previously predicted as the Fed scrambles to manage a rapidly shifting economy. The Fed is now widely expected to begin raising rates in March - action that would, in turn, raise borrowing costs for many consumers and businesses.

By waiting as long as it has, the Fed might eventually be forced to accelerate its rate increases, effectively pressing harder on the economic brakes. Yet that could slow growth, disrupt financial markets and potentially cause a recession.

Many past recessions have been caused by aggressive Fed rate hikes that were intended to combat or prevent inflation.

Last month, in a sharp pivot toward fighting inflation, the Fed signaled that it expects to raise its short-term benchmark rate, currently near zero, three times this year. As recently as September, policymakers had been divided over whether to raise rates even once in 2022.

"There is a substantial risk that the Fed is sufficiently behind the curve that it will need to face the challenge of letting inflation remain persistently high or risk a recession," said Tim Duy, chief U.S. economist at SGH Macro Advisors.

Stocks have tumbled and bond yields have surged since the minutes of the Fed's December meeting, released last week, showed officials likely to move more faster to tighten credit.

Many economists now expect the Fed to raise its key rate at least four times this year. And according to the minutes of its December meeting, Fed officials are also considering moving faster to shed the nearly $8.8 trillion in Treasury and mortgage bonds they hold, a move that would also tighten credit. The minutes indicated that the policymakers could start letting those holdings decline, as the securities mature, as soon as after the Fed's first rate hike.

For now, the Fed's policies reflect mostly the emergency settings that have been in place since the pandemic struck in March 2020. Besides pegging rates at essentially zero, the Fed is still buying bonds to try to hold down longer-term rates.

Those bond purchases are set to end in March.

Yet on Friday the government reported that the unemployment rate sank in December to 4.2% from 3.9% in November and is down from 6.7% a year earlier - the fastest 12-month drop in the jobless rate since records began in 1948.

With the number of unemployed dwindling, businesses have been forced to raise hourly pay to keep and attract workers. In the final three months of 2021, wages jumped at a 6.2% annual rate. And for workers in restaurants, hotels and casinos, pay soared 14.1% in December compared with a year ago.