Fed chair sees the rollout of COVID vaccinations as a positive for the U.S. economy, but fiscal stimulus is crucial for next few months.
The Fed decided to keep its target interest rate in the 0% to 0.25% range at its December meeting and is also more optimistic about the economic outlook with the availability of vaccines. This means credit card interest rates, which are based on the Fed’s targeted interest rate, are likely to remain in their current range.
In a statement, the Federal Open Market Committee, the Fed’s rate-setting body, noted, “The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will continue to weigh on economic activity, employment and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.”
The action was unanimously supported by FOMC members. The Fed aims to maintain its near 0% target interest rate until labor market conditions are optimal and inflation touches 2% and is on track to exceed that level for some time. Considering that inflation has run below 2% for a considerable period of time, allowing it to cross the 2% threshold will make for an average inflation of 2% over time.
The central bank will also continue with its purchases of at least $80 billion each month in Treasury securities and $40 billion a month of agency mortgage-backed securities in its bid to achieve its inflation and employment goals and ensure the smooth flow of credit in the economy.
Fed more optimistic about economic outlook
It seems Fed members are more optimistic about the economic outlook than they were in September. For instance, they expect U.S economic output for 2020 to decline 2.4%, compared to the September projection of a 3.7% contraction. They expect the unemployment rate for the year to be at 6.7%, from September’s forecast of 7.6%. Their expectations for inflation remain the same, though, at 1.2%.
The Fed is also more optimistic about the employment outlook for 2021, expecting that unemployment will be at 5%, down from September’s 5.5% projection. It expects inflation to rise to 1.8% in 2021, up from a September projection of 1.7%.
In a related press meeting, Fed Chair Jerome Powell noted that fewer Fed members see “risks weighted to the downside for economic activity,” based on the input they provided. While the recovery has proceeded “more quickly than expected, the path ahead remains uncertain.”
Powell said the recent news about vaccines has been “very positive,” but uncertainty remains about the timing, distribution and efficacy of vaccinations. Thus, the public should remain vigilant about following health guidelines on wearing masks and social distancing.
Powell continues to see need for fiscal stimulus
As he has been doing for some time now, Powell continued to make a case for fiscal stimulus.
“It may take continued support from both fiscal and monetary policy to get the economy back to where it was at the beginning of the year,” he said.
The Fed cannot grant loans to particular beneficiaries, and many are finding it difficult to get a loan. And with the upcoming expiry of unemployment benefits and the virus spreading the way it is, more stimulus is necessary.
Fiscal policy has helped so far into the recovery and “the case for fiscal policy right now is very, very strong,” Powell said. He declined to comment about whether the currently proposed $900 billion stimulus package is sufficient and would prefer to leave the details to Congress.
Although a growth in COVID cases in the past has held back the economy less than expected, the current spike is so much larger – with case numbers so high and widespread across the country – that it is bound to have an effect, Powell expects, and some early high frequency input points in this direction.
He is not unduly concerned about the potential for any fiscal stimulus actions to add to the fiscal deficit, considering that real interest rates are running so low now.
For its part, the Fed is prepared to increase the size of its asset purchases, or move toward purchasing bonds with longer maturities, if it feels a need to do more.
However, “The economy is not suffering from a lack of accommodation, but from the virus,” Powell noted.
Covid vaccinations are a positive
As people get vaccinated, they will feel more comfortable going out and engaging in a range of activity. While this will help the economy perform stronger in the second half of 2021, the issue is tiding over the next four to five months, and that interim period requires the fiscal stimulus that Powell is calling for.
As to when the U.S. will be at a state of “herd immunity” that will protect people from further COVID infections, Powell said it depends on assumptions such as how many people will get vaccinated and how fast the vaccine rollout will be. Based on this, the U.S could get to herd immunity as early as the middle of next year.
Powell is not concerned that the release of pent-up consumer demand for activities such as travel will lead to a spike in service-sector inflation next year, considering that a one-time spike has not led to inflation in the past.