Though uncertainty is high, the Fed must rapidly respond to the data it has today and then adjust as necessary as conditions evolve
is more spread out and partly offset by tax rises). During the pandemic, consumers have binged on goods. Supply chains have been bunged up, especially as the world’s factories have faced lockdowns and staff absences. Despite an abnormal number of Americans out of work, firms haveHowever, predicting when these pandemic-related forces will ease is a fool’s errand, especially now that theis spreading. For as long as inflation remains high, there is a growing danger that it will become entrenched.
The latest argument from some doves is that nominal GDP, or total cash spending in the economy, is merely on its pre-crisis trend. This proves that pandemic-related distortions, not excessive demand, have driven up prices, they say. Yet though this argument held in the third quarter, it may already be. Nominal GDP is expected to grow at annual rates of over 10% in the fourth quarter, compared with the trend rate of just 4%.
Tighter monetary policy is therefore justified. But if you believe the Fed’s theory of how its asset purchases work, every bond it buys adds fresh stimulus to the economy. It follows that merely tapering the pace of purchases is not tightening. So why not raise interest rates instead? The answer is that the Fed is bound by its past guidance that it would stop buying bonds before raising rates, and that it would avoid ending purchases abruptly.
The good news is that the Fed can taper fast enough to let it raise interest rates in March. If between now and then the pandemic greatly worsens, consumers slash their spending on goods or many missing workers return to the labour force, monetary policymakers can change course again. But they must give themselves the option of raising rates soon. In an ideal world it is an option that would already be on the table.