Why the Fed was slow to hike interest rates: The Taper Tantrum and a road trip : The Indicator from Planet Money The Fed hiked interest rates by 0.75 percentage points. But why the sudden jump now? Why not earlier? To understand the psyche of the Fed and its chair, Jerome Powell, we're turning back the clock to the 2013 Taper Tantrum, and a 2019 road trip.

Jerome Powell's ghosts

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SYLVIE DOUGLIS, BYLINE: NPR.

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ADRIAN MA, HOST:

So the big economic news of today...

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JEROME POWELL: It is essential that we bring inflation down.

MA: ...Was that Jerome Powell, the chair of the Federal Reserve, the U.S. Central Bank, announced that the Fed was raising interest rates by three-quarters of a percentage point.

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POWELL: ...That ongoing increases in that rate will be appropriate.

DARIAN WOODS, HOST:

Zero-point-seven-five - this is the highest rate increase we've had since 1994. It's meant to bring down high price inflation by making it harder for everybody to borrow and spend. But this big jump is quite a change in strategy than what the Fed has had over the last year. It's kind of had this extremely slow and steady, boil-the-frog-gently kind of thing. Like, Jerome Powell took a very long time to start announcing that the Fed was going to raise interest rates, which it started doing this year, even though inflation was really high last year.

MA: You know, there are a lot of people that said this approach took too long. Like, The Economist magazine, for instance - they ran a headline a few months ago that said, "The Fed That Failed."

WOODS: That is brutal. And there are a lot of reasons why the Fed kind of took its time to fight inflation. But we really wanted to understand the psyche of the Fed and its chair, Jerome Powell - and in particular, two episodes from recent history that shaped Powell's thinking.

This is THE INDICATOR FROM PLANET MONEY. I'm Darian Woods.

MA: And I'm Adrian Ma. Today on the show, the ghosts from Jerome Powell's past - ghosts that have haunted him throughout the pandemic that might have contributed to this inflation mess we're in right now.

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WOODS: To better understand the Fed's thinking, we're going to start with what's called the taper tantrum.

MA: Ah, yes - the fabled taper tantrum. So bring your mind back to 2008, the height of the financial crisis. The Fed had already brought short-term interest rates down to zero, but the economy still needed a further nudge in the ribs, right? It needed more stimulus. And so the Fed tried to do something new. It started to buy up what would eventually become trillions of dollars of assets to help drive down long-term interest rates. And this is what became known as quantitative easing, or QE.

WOODS: So essentially, the Fed wanted interest rates really low. So it bought a bunch of bonds, which meant that those bonds didn't need high interest rates to attract buyers. And those low interest rates were intended to stimulate the economy.

MA: But quantitative easing was meant as a temporary measure - right? - something just to get the country through the 2008 crisis. And so several years later, by 2013, some members of the Federal Reserve Board, which decides monetary policy - they were getting antsy. And one of the people on that board was Jerome Powell. So him and a couple of other buddies on the board said to Ben Bernanke, look, we got to get back to something closer to normal. We got to reel in this bond buying.

WOODS: In a Fed meeting in June 2013, Jerome Powell got even blunter. He acknowledged that yes, no kind of action was risk-free, but - these are his actual words - we've got to jump. So he was meaning they need to get out of QE.

MA: And so that day, because of that pressure that Jerome and his colleagues were putting on Bernanke, Bernanke walked over to his usual press conference, in front of the reporters and the cameras, and he announced a scenario for slowing down QE purchases, for tapering off the buying of bonds. And just listen closely to this 'cause this might be one of the most expensive sentences ever uttered in the 2010s.

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BEN BERNANKE: If the incoming data are broadly consistent with this forecast, the committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.

WOODS: It sounds so innocent and, you know, dull, almost.

MA: Yeah, no.

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UNIDENTIFIED REPORTER #1: We all know it. When Ben Bernanke talks, the markets listen.

UNIDENTIFIED REPORTER #2: A major sell-off on Wall Street as the markets stand and revolt against Ben Bernanke and the Fed. Worry about interest rate rises down the road.

WOODS: The bond markets were essentially crashing in this way that Jerome Powell and his colleagues hadn't anticipated. The financial press dubbed it the taper tantrum, and this was like the Fed had slammed on the brakes when it was only talking about eventually easing up on the accelerator.

MA: Jerome was reportedly pretty shaken by all this, saying, oh, my goodness, to Ben Bernanke, who replied something along the lines of, don't worry. You weren't here for 2008. This is nothing. But for Powell, it was something he would carry. I mean, here he is talking about it in 2019.

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POWELL: The taper tantrum left scars on anybody who was working at the Fed at that time, and I think the takeaway was that the market could be very sensitive to news about the balance sheet.

MA: This was the lesson - be very slow and steady with your tightening messages - so slow and predictable, it's like watching paint dry. And Jerome Powell carried this lesson into the pandemic when the Fed launched a new round of quantitative easing.

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POWELL: We will purchase at least 500 billion of Treasury securities over the coming months.

WOODS: So then in 2021, when the American economy is doing surprisingly well and inflation is rising, Powell's hints and slow buildup to tapering had prepared the markets so that when the announcement finally came in November...

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POWELL: It is time to taper, we think, because the economy has achieved...

WOODS: There was not a 2021 equivalent of a type of tantrum.

MA: So it worked. Lesson learned, right? Well, the flip side of not spooking the markets was that, in the meantime, inflation grew and grew to the point that now people are talking about the Fed needing to trigger a recession to help bring it down.

WOODS: OK. So the taper tantrum was Jerome Powell's first ghost. And the second ghost can be illustrated from the closest that Fed economists would ever get to joining a rock band tour bus. So it was this road tour in 2019 called Fed Listens. It was this round the country consultation with union members, with small business owners, community college leaders. And they were there to hear essentially how America was feeling about the economy and whether the Fed should change how it thought about it.

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MARK LEVINSON: And I think the Fed has been slow to recognize that the dynamics between inflation and a tight labor market, you know, are not what they were in the '70s.

MA: This is Mark Levinson, chief economist at the Service Employees International Union. And he's speaking at one of these Fed Listens meetings in New York. And what Mark was saying was that, in the past, low unemployment often meant high inflation. You know, as a hot labor market gains steam, that might raise wages and put inflationary pressure on the rest of the economy. But in the years before the pandemic, unemployment was actually getting really low, and inflation was also really low. And so he was saying maybe there isn't such a trade-off. Maybe this could actually be a win-win - low inflation and low unemployment rates, which could also have benefits for groups of workers that have been historically marginalized.

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LEVINSON: The benefits of tight labor markets - real wage gains that noticeably go to lower- and middle-class workers, that go to African-American workers.

WOODS: And that year, where the Fed Listens tour had started in 2019, the Fed started lowering interest rates, making it easier for companies to borrow and hire more people. And unemployment fell so much that low-waged workers, Black workers and Latino workers were getting pay rises. And for a moment, income inequality was falling, and inflation wasn't rising very much. It was another lesson for Powell, which he also took into the pandemic. And here he is at a press conference in September 2021.

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POWELL: We also said we wouldn't raise rates just in response to very low unemployment in the absence of inflation. So that was another aspect of it because we saw that that really benefited labor market participants in a broad and inclusive way.

MA: Jerome Powell learned not to raise interest rates simply because unemployment was low, and that was along with learning to give the markets a long lead time before the Fed makes big adjustments to its tightening policies. Those were the big lessons from the 2010s. But they weren't lessons that helped much to stem our current inflationary spiral.

BILL NELSON: I think that they waited too long.

WOODS: Bill Nelson was high up at the Fed during the taper tantrum, and today he thinks the Fed has made a historic mistake.

NELSON: They should have realized they had such a long way to go that they really needed to get started.

WOODS: Bill Nelson's itemized list of why the Fed was so slow to combat inflation, next week.

This episode was produced by Nicky Ouellet and engineered by Robert Rodriguez. Catherine Yang (ph) checked the facts. Our senior producer Viet Le edited this episode. Kate Concannon is our editor. And THE INDICATOR is a production of NPR.

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