Rising coronavirus cases & supply chain bottlenecks underline the Fed’s inflation dilemma

Fed officials will gather on Tuesday and Wednesday to discuss a policy shift in the face of rising coronavirus cases and strained supply chains, that may lead to rising inflation.

Slowed growth and increased prices threaten to destroy the rosy picture the Federal Reserve had anticipated six weeks ago as the contagious delta coronavirus variant has led to a rise in daily infections.

Increased coronavirus infections will impact consumers' willingness to spend and travel. The Fed will need to strike a balance between maintaining the optimism surrounding the economic recovery while taking into account everything that could go wrong.

The new policy statement will be issued on Wednesday at 2 PM ET, followed by a press conference by Federal Reserve Chair Jerome Powell.

The Fed Chair is likely to discuss the eventual tapering of the Fed’s $120 billion monthly asset purchase program at the press conference. The conversations about the program began last month, and have increased after the inflation and payrolls data rose way above economists’ expectations. 

The Fed has repeatedly assured the public that it will continue its asset purchase program until it witnesses “substantial further progress” concerning inflation and employment. Powell had earlier said that the threshold was still “a ways off”. This remark is threatened by the rising number of Delta coronavirus variant cases in the US.

Earlier the Fed had expressed confidence as COVID-19 cases had decreased but since then the rate of vaccination has fallen threatening recovery.

Since the beginning of the pandemic, around 6.8 million jobs were lost. The U.S.’s emergence from the pandemic depends on economic recovery and hiring continuing apace. If a slowdown occurs when the Fed pulls back its fiscal spending and benefits program, the economic growth will fall from its high pace of around 7%.

The task that lies in front of the Fed is to balance increasing prices which are growing at a faster rate with the economic growth which is relatively slower and increase hiring before changing the monetary policy.

Meanwhile, supply-side bottlenecks continue to jeopardize industrial manufacturing and production which is pertinent to economic growth. Floods in Germany and China are delaying the delivery of materials around the world, extending the supply bottlenecks that the Fed officials are counting on to ease inflation.

Earlier in July, the Labor Department reported that the cost of imported goods in the U.S. rose to 11.2% year-on-year for the seventh straight month in June import prices. The report reflected that inflation would persist as the domestic demand surges in the face of global supply chain restrictions. 

The government also reported the largest increase in the consumer price index (CPI) to 5.4% y-o-y, in 13 years, this month, while producer prices accelerated. A week before that Fed Chair Powell said that inflation “has increased notably and will likely remain elevated in coming months before moderating.”

Analysts believe that input costs and supplier wait times will continue to persist in consumer inflation. Fed Chair Jerome Powell has repeatedly said the rise in inflation is a temporary effect of the economy getting back to normal, and that the Fed has tools to respond if the surge goes on too long.

The Fed is now faced with two options — the persistence of more embedded inflation along with risks to growth and the withdrawal of federal fiscal support.

(With inputs from Reuters)

Picture Credits: Financial Times