The FOMC: What Will It Do?

The issue of when and how much the Fed should adjust policy is in the news but it is hardly new. The issue has been a constant in Fed deliberations through most of the last decade and will be with us during most of the next decade. The Fed must begin to taper, and rates must eventually be increased, but no one knows how that will evolve, not even the Fed.

There is, a will continue to be, those on the FOMC who wish to hold off removing the vast accommodation introduced into our financial system and economy. They are convinced the supply issue is mostly temporary and that moving rates up will slow the economy prematurely. But there are other members of the committee equally convinced that inflation in prices of goods and services, and assets, needs to be addressed soon.

On balance while supply disruptions are putting upward pressure on prices, and it would be a mistake to increase rates too quickly, the Fed must do more than taper the growth of its balance sheet. It has been highly accommodative and for a period far longer than seems necessary. Interest rates at zero are accelerating the increase in asset prices and again creating the specter of winners (who have assets and losers who cannot afford to acquire assets, including the purchase of a new home or the ability to earn enough interest to save for the needed down payment. Price inflation will only make this unfortunate situation worse.

Unfortunately, recent history suggests that the Fed most likely will error on the side of accommodation beyond its usefulness. If so, inflation will, through the next two years at least, run above the 2 percent target and asset values continue to increase, favoring some groups over others. And with inflation increasing, the inflation tax will be a bitter additional pill that an important proportion of the public will have to endure.

Finally, if the Fed chooses to delay and fails to put a long-term plan in place to not only taper its balance sheet but to address inflation in both assets and prices, then the issue of financial stability will be the next headline to contemplate.