The Federal Open Market Committee (FOMC) is meeting this week for a regular meeting that involves more than the usual issues. President Jerome Powell and his colleagues must decide quickly whether to defend the credibility and independence of the Federal Reserve. Otherwise, they might find they missed their opportunity.
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The obvious but not the only credibility challenge is inflation. Consumer price increases reached 5% year-on-year in May, and 3.8% excluding food and fuel. This followed 4.2% inflation in April and significant increases in producer prices throughout the spring.
Part of this is due to so-called base effects, the comparison to prices deflated by the pandemic a year ago. Some of them stem from supply chain bottlenecks and the release of pent-up demand that will dissipate. The Fed is also pointing to the fall in 10-year Treasury yields as a sign that the markets are not afraid of inflation.
But an optimistic approach to current price movements still carries risks. Inflation may prove to be less transient than expected if the Biden administration’s spending plans increase demand while its tax and regulatory policies restrict supply. The Fed’s unspoken weak dollar policy will exacerbate import price inflation. Even transient inflation will leave Americans permanently worse than they would be otherwise.
Inflation is already outpacing wage growth, despite the labor shortage in the United States, as rising unemployment benefits sideline workers. Inflation-adjusted wages edged down in May for the second month. The Fed seems to believe the solution is to keep Mr. Powell’s foot on the gas to further stimulate employment. But vacancies are at an all-time high as employers compete for workers. If that doesn’t spur wage growth faster than inflation, the Fed should ask why?