Federal Reserve bankers are optimistic about the direction that inflation is heading but still worried about reaching their target of 2 percent inflation, according to the minutes of the bank’s latest meeting of its rate-setting committee, which were published Wednesday.
“Almost all participants observed that slowing the pace of rate increases at the current juncture would allow for appropriate risk management as the Committee assessed the extent of further tightening,” the minutes say.
At the beginning of this month, the Fed made its smallest rate increase since it started raising rates a year ago, lifting them by just a quarter of a percent.
But bankers also expressed concern during the meeting “that a policy stance that proved to be insufficiently restrictive could halt recent progress in moderating inflationary pressures.”
This could lead to inflation remaining above the bank’s 2 percent objective for a longer period and pose a risk of inflation expectations becoming unanchored, according to the January meeting minutes.
Just two days after that meeting, a massive January jobs report showing unemployment was down to a 54-year low was published by the Labor Department, surprising many economists including those at the Fed.
Usually, rising interest rates are associated with increases in unemployment. But the labor market has been all but oblivious to the effects of eight consecutive interest rate hikes, and that has led to deep disagreements among economists.
Inflation has been falling since last summer, with the U.S. consumer price index dropping to 6.4 percent in January from a high of 9.1 percent last June. That’s seven months of declines in a row even as the labor market has refused to budge.
“Then comes the labor market report for January — and it’s very strong. It’s certainly stronger than anyone I know expected. I would say we didn’t expect it to be as strong,” Federal Reserve Chair Jerome Powell said at an event in Washington earlier this month.
The minutes contained some mixed signals about an economy that’s refusing to obey some classical economic models.
Fed bankers “observed that risks to the economic outlook were becoming more balanced” just as they worried about the “risk of inflation expectations becoming unanchored.”
The Fed’s rate-setting committee has more than a dozen members, and they’re rarely if ever in total agreement with each other.
Central bankers also called out “profit margins” as a driver of inflation, something the Fed mentioned only once during its eight meetings in 2022.
“[Rate-setting committee members] noted the possibility that as consumers become more price sensitive, businesses might accept lower profit margins in an effort to maintain market share, which could reduce inflation temporarily,” the minutes say.
In September, the bank made a similar argument, reasoning that inflation could abate because “weaker consumer demand would result in a reduction of business profit margins from their current elevated levels.”
Private-sector profits have soared during the recovery from the coronavirus pandemic as inflation rose to 40-year highs, rising above $3 trillion in both the third and fourth quarters of 2022.
Inflation-adjusted profits as a share of production have also risen since the pandemic from around 14 cents on the dollar in the decade before the pandemic to well over 20 cents last year.
“What has been missing throughout the Fed’s tightening cycle is a clear narrative as to what rate hikes will achieve,” UBS banker Paul Donovan wrote in a note to investors on Wednesday, adding that “rates are a clumsy way of tackling profit-led inflation.”
It’s affected many different countries and not just the U.S.
In a report published last year, economists with the United Nations Conference on Trade and Development wrote that global inflation was being “amplified by price-setting firms in highly concentrated markets raising their mark-ups.”
“While it is indisputable that profit shares have risen, it is not clear what this means,” economist Dean Baker wrote in an email to The Hill.
“For example, the egg producers have seen a huge rise in profits due to the shortage created by the Avian Flu. We would expect prices to rise when there is a shortage. The alternative would be keeping prices low and very quickly having empty shelves. That is not obviously a better outcome, and it would be hard to imagine corporations (who are always greedy) choosing to forego profits for no obvious benefit,” he wrote.