The Federal Reserve is opening the door to possible interest rate hikes earlier next year than had been expected, as it wrestles with the highest inflation in nearly four decades.

Transcript

AUDIE CORNISH, HOST:

With consumer prices climbing at their fastest pace in nearly 40 years, watchdogs at the Federal Reserve announced some important policy changes today. The moves could set the stage for the Fed to raise interest rates earlier next year, if necessary, to keep inflation from spiraling out of control. NPR's Scott Horsley joins us now. And, Scott, how alarmed is the Fed by the inflation figures that have been reported in recent days?

SCOTT HORSLEY, BYLINE: Audie, the Fed is definitely on the alert. Consumer prices in November were up 6.8% from a year ago. That's the highest inflation rate since 1982. Wholesale prices, which came out just yesterday, were up even more sharply, and this increasingly seems like it's not just a short-term blip. Fed Chairman Jerome Powell and his colleagues have been keeping a close eye on wages, which have been climbing rapidly. So far, we're not seeing a lot of relief from the labor shortages that employers have been clamoring about. Rents are also on the rise. The supply chain bottlenecks are taking a long time to unravel. Notably, in its statement today, the Fed dropped the word transitory, which it had been using to describe inflation in the past. Powell says it's looking more and more as though higher prices might be here to stay, at least for a while to come.

(SOUNDBITE OF ARCHIVED RECORDING)

JEROME POWELL: There's a real risk now that inflation may be more persistent, and that may be putting inflation expectations under pressure, and that the risk of of higher inflation becoming entrenched has increased. It's certainly increased. I don't think it's high at this moment, but I think it's increased, and I think that's part of the reason behind our move today.

CORNISH: So what's the policy response?

HORSLEY: Well, early in the pandemic, the Fed had slashed interest rates close to zero. It's also been buying more than $100 billion worth of bonds every month to prop up the economy and keep long-term interest rates low. Last month, the Fed had said the economy had recovered enough to start winding down those bond purchases, and it planned to do that in a gradual way over six months or so, so it would be finished up next summer. Today they announced they're speeding up that timetable, so the bond purchases will likely end in March. That means a little less gas on the inflationary fire, but it also means the Fed is taking a step closer to its big fire extinguisher, which would be raising interest rates. It looks like we could see earlier rate hikes next year and more of them. In fact, a majority of policymakers on the Fed's rate setting committee now say they expect the central bank to raise rates by three quarters of a percentage point or more next year. Just back in September, nobody on the committee thought that level of rate hikes would be necessary

CORNISH: If just raising the interest rate could be a good weapon for this, why not deploy it sooner?

HORSLEY: Well, there is typically a trade-off. It does help to keep inflation in check, but higher interest rates also typically means slower economic growth, slower job growth. The U.S. is still almost 4 million jobs short of where it was before the pandemic. And the Fed had said last year it wouldn't raise rates from zero until the economy had reached maximum employment. It seems like we're a long way from that. But, you know, Powell and his colleagues now think we might be closer to full employment than it appears because they think a lot of the people who dropped out of the workforce during the pandemic may not be coming back anytime soon.

(SOUNDBITE OF ARCHIVED RECORDING)

POWELL: The longer the pandemic goes on, you know, maybe the less likely that people will come back because they're, you know, they get used to their new life and they lose contact with their old jobs. That's what the evidence would say.

HORSLEY: Now, that doesn't mean those workers will never come back to the workforce, but it could take a long time. And Powell says the Fed can't afford to let inflation run wild while they wait for that to happen.

CORNISH: Did the Fed talk at all about coronavirus, the variant? Obviously, there's an increase in hospitalizations.

HORSLEY: That's right, and that has a potentially mixed effect on the economy. The earlier wave of delta infections affected both supply and demand, so the net impact on inflation can be mixed. Powell says the same could be true of omicron, but it's just hard to know right now.

(SOUNDBITE OF ARCHIVED RECORDING)

POWELL: And it's very difficult to say what the economic effects would be. I do think wave upon wave, people are learning to live with this. More and more people are getting vaccinated. We'll know a whole lot more in three weeks, and we'll know more than that in six weeks.

HORSLEY: And financial markets seemed to welcome the Fed's new, tougher policies on inflation. The Dow jumped 383 points today, or more than 1%. The Nasdaq rose more than 2%.

CORNISH: That's NPR's Scott Horsley. Thanks for this update.

HORSLEY: You're welcome. Transcript provided by NPR, Copyright NPR.

Tags: Fed Chairman Jerome Powell  U.S. economy  inflation  Federal Reserve  interest rates  Series: The Coronavirus Crisis