Fed Officials Fretted That Markets Would Misread Rate Slowdown

Federal Reserve officials worried that inflation could remain uncomfortably fast, minutes from their December meeting showed, and some policymakers fretted that financial markets might incorrectly interpret their decision to raise interest rates more slowly as a sign that they were giving up the fight against America’s rapid price gains.

Inflation is beginning to slow down but remains abnormally quick: The Personal Consumption Expenditures price index climbed by 5.5 percent in the year through November, down from a 7 percent peak in June 2022 but still nearly triple the Fed’s 2 percent inflation goal. Fed officials still saw inflation as unacceptably high, as of their meeting last month — and worried that rapid price gains might have staying power.

“The risks to the inflation outlook remained tilted to the upside,” Fed officials warned during their December policy meeting, minutes released on Wednesday showed. “Participants cited the possibility that price pressures could prove to be more persistent than anticipated, due to, for example, the labor market staying tight for longer than anticipated.”

Such risks set up a challenging year for Fed policymakers, who will need to decide how much more they need to raise interest rates — and how long they need to hold them at elevated levels — to bring inflation firmly under control. The Fed wants to avoid pulling back too early, which could allow inflation to become entrenched in the economy. But officials are also conscious that high rates come at a cost: As they slow growth and weaken the labor market, workers are likely to earn less and may even lose their jobs.

That’s why the Fed wants to tread carefully, bringing price increases under control without inflicting more damage than necessary. Officials slowed their rate increases last month, lifting their main policy rate by half a point after several three-quarter-point moves in 2022. Officials forecast that they would raise rates by more in 2023, but their estimates suggested that they were nearing the level at which they might pause: They saw rates climbing to about 5.1 percent in 2023, up from about 4.4 percent now.

Inflation F.A.Q.

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What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today. It is typically expressed as the annual change in prices for everyday goods and services such as food, furniture, apparel, transportation and toys.

What causes inflation? It can be the result of rising consumer demand. But inflation can also rise and fall based on developments that have little to do with economic conditions, such as limited oil production and supply chain problems.

Is inflation bad? It depends on the circumstances. Fast price increases spell trouble, but moderate price gains can lead to higher wages and job growth.

How does inflation affect the poor? Inflation can be especially hard to shoulder for poor households because they spend a bigger chunk of their budgets on necessities like food, housing and gas.

Can inflation affect the stock market? Rapid inflation typically spells trouble for stocks. Financial assets in general have historically fared badly during inflation booms, while tangible assets like houses have held their value better.

“Participants concurred that the committee had made significant progress over the past year in moving toward a sufficiently restrictive stance of monetary policy,” the Fed’s minutes said, referring to the rate-setting Federal Open Market Committee. But more rate moves were judged to be needed, and no officials expected to cut rates in 2023.

“Participants generally observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2 percent, which was likely to take some time,” the minutes said.

Officials emphasized the importance of retaining “flexibility and optionality” — Fed-speak for wiggle room to change their stance abruptly in a world of many uncertainties.

But policymakers worried that markets might misinterpret their decision to slow the pace of rate moves, seeing it as a sign of a “weakening of the committee’s resolve to achieve its price-stability goal,” or a judgment that inflation was already making enough progress in slowing down. Policy works through financial markets, and if market-based rates dip or stock prices soar, that can make it cheaper and easier to borrow.

“An unwarranted easing in financial conditions, especially if driven by a misperception by the public of the committee’s reaction function, would complicate the committee’s effort to restore price stability,” the minutes said.

Understand Inflation and How It Affects You

  • Social Security: The cost-of-living adjustment, which helps the benefit keep pace with inflation, is set for 8.7 percent in 2023. Here is what that means.
  • Inflation Forecasts: Economists misjudged how much staying power inflation would have in 2022. Things could now get better — but there’s ample room for humility.
  • Tax Rates: The I.R.S. has made inflation adjustments for 2023, which could push many people into a lower tax bracket and reduce tax bills.
  • Your Paycheck: Inflation is taking a bigger and bigger bite out of your wallet. Now, it’s going to affect the size of your paycheck in 2023.

Fed interest-rate increases slow the economy by making it more expensive to borrow to buy a house or expand a business. But their impact is not immediate: It takes time for firms to allocate lower budgets for hiring, for instance, which can then snowball into less power for job applicants, slower wage growth and weaker consumption.

That delayed reaction is why central bankers want to give their policy changes time to play out. Officials want to avoid raising rates higher than necessary, especially at a time when inflation is already slowing down as supply chains heal and fuel becomes cheaper.

But Fed policymakers also think inflation has moved into a new phase, one where it will not simply fade on its own as supply problems clear up. Wages are increasing rapidly enough that firms are likely to continue raising their prices to cover climbing labor bills, they think, making it hard for inflation to return fully to normal.

By slowing economic demand, officials are trying to counteract that, slowing the labor market, bringing pay gains back to more normal levels and allowing inflation to settle down on a sustainable basis.

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