With Progress Made, But Persist High Inflation What’s the Next Move?

Minutes from the Federal Reserve's December meeting revealed that central bankers were dedicated to bringing down inflation, but officials see higher rates for ‘some time’ ahead.

The minutes from the Federal Reserve's December meeting revealed that members were worried that inflation could remain high and that the financial markets would misunderstand their decision to raise interest rates more gradually as a sign that the Fed was giving up the fight against the United States' rapid price gains.

The price index for personal consumption expenditures rose by 5.5% year-over-year through November, down from 7% in June but over twice the Fed's 2% inflation objective. At their meeting last month, Federal Reserve policymakers continued to see inflation as unacceptably high and expressed concern that recent price increases may be sustained.

From the Federal Reserve's policy meeting in December, which was made public on Wednesday, the officials expressed concern that there was still an upward bias to the risks associated with the inflation forecast. "Participants acknowledged the likelihood that pricing pressures might prove to be more persistent than expected" for reasons such as the labor market being tight for a longer period of time than was originally predicted.

The Fed's officials will have to determine how much farther they need to increase interest rates — and how long they need to keep them at high levels — to get inflation firmly under control, which will make for a hard year for them. It is in the Fed's best interest to refrain from tightening monetary policy too quickly since this might make it easier for inflation to take root in the economy. However, policymakers are also aware that high rates come with a cost: since they hinder development and undermine the labor market, employees' wages are likely to decrease, and some people may even lose their employment.

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Because of this, the Federal Reserve wants to proceed cautiously to keep inflation under control without causing any more harm than necessary. After making numerous adjustments of three-quarters of a percent in 2022, the officials reduced the pace of their rate rises last month, raising their main policy rate by half a point. Officials projected that they would hike rates even more in 2023; nevertheless, their calculations showed that they were getting dangerously close to the point when they would pause: They forecasted a rise in rates from the current level of around 4.4 percent to approximately 5.1 percent in the year 2023.

Participants acknowledged that the committee had achieved substantial progress over the last year in moving toward an appropriately restrictive posture of monetary policy," it says in the minutes of the Federal Open Market Committee, the group that controls interest rates. All agreed that the committee had made substantial progress toward an appropriately restrictive monetary policy stance during the previous year. The opposite was shown to be true; more rate adjustments were found to be necessary, and no authority predicted a rate cut in 2023.

Participants "generally understood that a tight policy stance would need to be maintained until incoming figures offered confidence that inflation was on a sustained downward path to 2 percent," the minutes said.Officials underlined the need to maintain  "flexibility and optionality," which is Fed-speak for wiggle space to alter their attitude unexpectedly in a world filled with many unknowns.

However, policymakers were concerned that markets might misread their decision to limit the pace of rate changes, viewing it as a sign of a "weakening of the committee's willingness to accomplish its price-stability target" or a judgment that inflation was already making sufficient headway in slowing down. The financial markets are the conduit through which policy is implemented, and if market-based interest rates fall or stock values surge, this may make it cheaper and simpler to borrow money.

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The committee's work to restore price stability would be hampered by "an unnecessary relaxation in financial circumstances," according to the minutes. This would be particularly true if it were caused by a public misunderstanding of the committee's response function.

When the Federal Reserve raises interest rates, consumers and businesses face higher borrowing costs, which affects economic activity. Nonetheless, their effects are delayed: For example, it may take some time for companies to reduce their expenditures for recruiting, which may have a domino effect of reducing the bargaining power of job seekers, reducing wage growth, and reducing consumer spending.

Because of this delayed response, central bankers aim to allow their policy adjustments sufficient time to play out. Officials aim to avoid boosting interest rates by more than is absolutely required, particularly when inflation is already down due to supply chains being repaired and gasoline being less expensive.

However, officials at the Federal Reserve believe that inflation has entered a new phase, one in which it will not just fade away once supply constraints are resolved. Officials believe that since wages are rising at a sufficiently quick rate, businesses are likely to continue increasing their prices to meet the rising cost of labor, making it difficult for inflation to return to normal levels.

They are attempting to offset this by decreasing economic demand, which has the knock-on effect of slowing the labor market, bringing pay rises back to more normal levels, and enabling inflation to settle down on a sustainable foundation.

                       Fed releases minutes from December meeting, officials see higher rates for ‘some time’ ahead