The Fed says it has a plan to deal with inflation which is at a 30-year high
NOEL KING, HOST:
The Fed says it will start scaling back the economic aid it provided during the pandemic. It's going to taper bond-buying, but it will also keep interest rates near zero. David Wessel from the Brookings Institution is back with us. Good morning, David.
DAVID WESSEL: Good morning, Noel.
KING: OK, so explain how bond-buying stimulates the economy in the first place.
WESSEL: OK. So at the beginning of the pandemic, the Federal Reserve set short-term interest rates to zero. But it wanted to continue to provide some support to the economy, so it started buying $120 billion a month in bonds and mortgage-backed securities to depress longer-term interest rates, like the ones we pay on mortgages. And what the Fed said yesterday is they're going to gradually taper is the word by cutting that 15 billion a month so that by the middle of next year, they won't be buying any bonds. Now, this probably won't have any direct effect on consumers. But over time, it'll tend to lift long-term interest rates, like the ones that people pay when they get a mortgage to buy a house.
KING: And the Fed is doing this now why, because everything's gone back to normal? I kid. But why now?
WESSEL: Well, actually, they're saying that we're getting close to normal.
WESSEL: They're saying that we've had a - we had a lousy patch because of the delta variant of the coronavirus. But they expect the economy to be picking up momentum, hiring. They're seeing a lot of price increases, and they're saying the private sector, consumers and businesses, are demanding enough so that the government sector, both the budget, tax and spending and monetary policy can pull back a little bit. So it's fundamentally their optimistic reading of the economy that they can wean it off of this extraordinary support they gave during the pandemic.
KING: Consumer prices, as you well know, have risen by 5.4% in the last year. Jerome Powell again said yesterday that this is transitory is the word we keep hearing. Let's play a little bit of that.
(SOUNDBITE OF ARCHIVED RECORDING)
JEROME POWELL: It remains the case that the drivers of higher inflation have been predominantly connected to the dislocations caused by the pandemic, specifically the effects on supply and demand from the shutdown, the uneven reopening and the ongoing effects of the virus itself.
KING: How unusual is it that this word transitory keeps being redefined to mean more time, more time, more time?
WESSEL: Well, the very nature of this pandemic and the economic response is unusual. The notion that the Fed would say that inflation is up to 5% and transitory is unusual. What Jay Powell is arguing is that there are kinks in the supply chain, there are backups at the ports, companies are having difficulty coping with this surge in consumer demand that came as we got vaccinated and began to go shopping again. He's saying, I don't want to put the brakes on the economy now because I think this upward pressure on prices is going to abate. But he admits that there's a risk here. And there are people inside the Fed and outside the Fed who warn that the Fed is taking a big risk here, that month after month of rising prices is going to lead people to expect higher inflation, and that'll become a self-fulfilling prophecy.
KING: Right - because then people start negotiating for higher wages, and they start assuming that the car that now costs $17,000 might cost $18,000 in a year. So a lot of this - a lot of these expectations, in a very interesting way, get baked in and become - can become realities. Let me ask you lastly - Powell's term as Fed chair is up in February. Do you think he's going to be reappointed?
WESSEL: We don't know when President Biden is going to make an announcement, but it sure looks to me like sometime soon he will make an announcement. And my expectation and that of most Fed watchers and people in the markets is that he will reappoint Jay Powell to a second four-year term and fill some of the other pending vacancies at the Fed with other people.
KING: David Wessel is director of the Hutchins Center on Fiscal and Monetary Policy at Brookings. David, thank you again.
WESSEL: You're welcome. Transcript provided by NPR, Copyright NPR.