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Updated on Thursday, December 16, 2021
As the U.S. economy continues its recovery amidst the coronavirus pandemic, the Federal Reserve Open Market Committee (FOMC) is responding more strongly to inflation. During its last meeting in November, the FOMC announced that it would be tapering its asset purchases — a key quantitative easing strategy for supporting economic activity. At this month’s meeting, the Fed announced an increase in the pace of that taper.
Federal Reserve Board Chair Jerome Powell, who was recently nominated for another term, had maintained that the Fed believed inflation to be temporary and supply-related. However, inflation reached 6.8% in November, marking the largest 12-month increase since June 1982.
When asked what prompted the Fed’s increased wariness toward inflation, Powell cited November’s Employer Compensation Index (ECI), unemployment numbers and that 6.8% increase in the Consumer Price Index (CPI).
“It was essentially higher inflation and faster — turns out much faster — progress in the labor market,” Powell said. “Really, what’s happening is that the unemployment rate seems to be catching up with the other readings of a tight labor market.”
The FOMC also released its latest Summary of Economic Projections (SEP), a quarterly collection of the committee’s economic predictions. It showed that all members surveyed predicted an increase to the federal funds rate next year — a significant change from the previous SEP in September, in which only half of those surveyed predicted a rate increase. It’s only a matter of time before “liftoff” (an increase to the zero-bound federal funds rate) happens.
What happened at the December Fed meeting
- FOMC committee members forecast strong Gross Domestic Product (GDP) growth, federal funds rate hikes and an inflation rate above the Fed’s 2% target in 2022.
- In the likely event that asset purchases will cease in Q1 of 2022, the federal funds rate liftoff will be the key monetary policy question facing the Fed next year.
- Labor market uncertainty continues to complicate the question of what constitutes maximum employment, as well as the Fed’s monetary policy decisions.
Strong GDP growth, lower unemployment forecasted for 2022
The FOMC released economic data projections for 2021, 2022, 2023, 2024 and the longer run as part of the SEP, which aggregates each meeting participant’s expectations for where those numbers will be at those times. Those participants forecast a 5.5% change in real GDP for 2021 and a 4.0% change in 2022 — a sign that inflation’s impact on the economy may not be too severe.
Notably, the 2022 unemployment rate expectation decreased from 3.8% in the September SEP to 3.5%, which is lower than the Fed’s 4.0% long-run goal and a sign that the U.S. economy is making progress toward full employment.
There is an increased expectation that inflation will persist into 2022. Personal Consumption Expenditures (PCE) inflation forecasts were revised upwards to 5.3% for 2021 (up from 4.2% in September) and to 2.6% for 2022 (up from 2.2%). Expectations are still anchored to a rate of 2.0% over the long run, but Powell said during his press conference that the 0.4 percentage point increase was “significant.”
Liftoff will be the biggest question moving forward
Powell has consistently said that the taper must be complete before any hike to the federal funds rate. The current timeline suggests an end to asset purchases in March, leaving plenty of time in 2022 for the Fed to increase the federal funds rate.
The federal funds rate dot plot in the December SEP shows a majority of committee members predicting three increases of 0.25 percentage points each to bring the federal funds rate to 0.75% by the end of the year. That tightening of monetary policy should help combat inflation, though the press release issued by the Fed ahead of the December meeting noted that “the path of the economy continues to depend on the course of the virus,” which has contributed to supply constraints.
That frequent refrain from the Fed has been an important reminder that the challenges facing the U.S. economy are closely tied to the COVID-19 pandemic. As such, traditional economic assumptions may not necessarily apply to these unique circumstances.
Labor market has improved, but there’s still uncertainty
While the unemployment rate fell to 4.2% in November, Powell again mentioned that the Fed considers a “broad range of indicators” when determining whether the U.S. economy has reached maximum employment. The Fed doesn’t have a certain unemployment rate threshold for determining full employment, instead subjectively weighing data across different statistics.
In any case, unemployment has declined steadily over the course of 2021, although labor force participation is a complicating factor.
“The reality is that we don’t have strong labor force participation recovery yet,” said Powell. “We may not have it for some time. At the same time, we have to make policy now, and inflation is well above target, so this is something we need to take into account.”
Fed meeting dates in 2022
Here is the FOMC’s calendar of scheduled meetings for 2022. Each entry is tentative until confirmed at the meeting proceeding it.
Past Fed meeting coverage
Read our analysis of the previous Fed meeting:
What Happened at the November 2021 Fed Meeting
- Fed will begin tapering purchases this month and, unless unforeseen circumstances arise, cease asset purchases by mid-2022.
- Powell was noncommittal when asked about what would constitute maximum employment, per the Fed’s mandate, as well as what the criteria would be for interest rate “liftoff.”
- As President Biden nears decision whether to reappoint Powell, he defends the Fed’s response to ethics questions with new regulations.
Asset purchase tapering is a sign of economic progress
In the FOMC’s press release, the committee stated that “with progress on vaccinations and strong policy support, indicators of economic activity and employment have continued to strengthen”; this has prompted the decision to taper the purchase of securities. However, the Fed also noted that continued economic progress would depend on the course of the COVID-19 virus, and that the rise in cases due to the Delta variant had slowed economic activity during the summer.
It’s the same cautiously optimistic line that the Fed has repeated for several months, but the action taken to taper asset purchases is a significant change from a long holding pattern. This action represents meaningful progress that has been made in the eyes of the FOMC: They believe that the economy has recovered enough to begin stepping back from the accommodative monetary policy that’s supported and stabilized the economy and financial system since the start of the pandemic.
Powell was evasive regarding liftoff, maximum employment
Although the FOMC judged that enough progress had been made to begin tapering the Fed’s asset purchases, they still kept the federal funds rate near zero. Powell has long maintained that the criteria for asset tapering and “liftoff” — the term commonly used to refer to the Fed’s decision to raise interest rates — would be different and that the committee has not focused on the liftoff test yet.
“We didn’t ask ourselves whether the liftoff test is met because it’s clearly not met on the maximum employment side,” Powell said.
When asked what would constitute maximum employment, Powell reiterated that it was a “broad-based and inclusive goal” that would encompass a variety of factors— these include labor market participation, what wages are like, how often employees are quitting, the number of job openings and how many people are moving from state to state for work. In short, the Fed will subjectively weigh a range of criteria instead of tying liftoff to the unemployment rate alone.
Powell defends Fed’s regulatory actions following ethics scandal
Earlier this year, two regional Fed presidents, Robert Kaplan of Dallas and Boston’s Eric Rosengren, resigned after their trading activity in 2020 came under scrutiny. In response, the Fed implemented new rules for senior officials, including prohibiting them from buying individual stocks, holding individual bonds, derivatives and mortgage-backed securities and requiring any trade to be approved in advance by the ethics board.
When asked whether the Fed would go further and force senior officials to put their assets in a blind trust, Powell said that these trusts would be too “cumbersome” and that the Office of Government Ethics advises against them. As to whether any laws had been broken, Powell deferred to the Inspector General and its investigation. Powell’s response to that ethics scandal will be an important consideration as Biden weighs whether to reappoint him to a second term.