Inflation got high. Why was the Fed slow to raise interest rates? : The Indicator from Planet Money What took the Fed so long to address high inflation? Today on the show, we're exploring six reasons behind the Fed's hesitancy to hike interest rates, according to Bill Nelson, who spent two decades working for the Federal Reserve. For more background, check out our episode last week, Jerome Powell's ghosts.

What took the Fed so long?

  • Download
  • <iframe src="https://www.npr.org/player/embed/1106893731/1106926708" width="100%" height="290" frameborder="0" scrolling="no" title="NPR embedded audio player">
  • Transcript

SYLVIE DOUGLIS, BYLINE: NPR.

(SOUNDBITE OF DROP ELECTRIC SONG, "WAKING UP TO THE FIRE")

DARIAN WOODS, HOST:

Here at THE INDICATOR, we are still feeling a little rattled.

WAILIN WONG, HOST:

Yes, we are. I still have my smelling salts in hand.

WOODS: You need to get those negative ions balanced, right?

WONG: (Laughter).

WOODS: We are still processing this unexpectedly high inflation reading that came in earlier this month. And this was followed by the Federal Reserve, the U.S. central bank, raising interest rates by three-quarters of a percent.

WONG: And today Fed Chair Jerome Powell testified before the Senate Banking Committee. He faced politicians grumpy about rising interest rates and high inflation - politicians like Senator John Kennedy.

(SOUNDBITE OF ARCHIVED RECORDING)

JOHN KENNEDY: Inflation is hitting my people so hard, they're coughing up bones.

WONG: And this situation isn't where anyone wanted to end up because even the Fed projects that more people might now have to be out of work. That's unfortunately what the Fed raising interest rates does. It makes the economy worse now with the hope that inflation will come down and the economy will be in a better place later.

WOODS: Inflation was ticking up quite a lot last year. And even though it's the Fed's job to keep prices stable, still, the Fed kept interest rates really low. It only started raising them recently. And so one question we want to get to the bottom of is, how did the Fed allow this to happen?

BILL NELSON: The typical plane crash involves seven consecutive human errors. And so that led me to think about the analogy for the Fed's actions.

WONG: Not to say our plane is going down.

WOODS: No, it's kind of just stalling a little bit, maybe. But just like plane crashes often don't have, like, a single cause of failure, economist Bill Nelson says there are a number of reasons that could have all conspired together to help inflation reach levels not seen since 1981.

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

WONG: And I'm Wailin Wong. And yes, hindsight is 2020, but we want to understand what happened. After the break - the six consecutive human errors that one former Fed official thinks led to the inflation mess we have today.

(SOUNDBITE OF MUSIC)

WOODS: Bill Nelson spent two decades working for the Federal Reserve, and he's now the chief economist of the bank lobbying group the Bank Policy Institute. And while Bill usually places more weight on the need to encourage a booming labor market than fighting inflation, even he thinks the Fed tightened too slowly.

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

WONG: So Bill has six main reasons why he thinks the Fed took too long. Reason No. 1 - which might sound familiar - the ghosts of Fed tightenings (ph) past.

NELSON: Sort of lingering regret over having tightened perhaps too soon out of concern for inflation that didn't materialize.

WOODS: We told the story of this low inflation period of the 2010s in last week's episode called "Jerome Powell's Ghosts." If you haven't already, we really recommend that you check it out for more in-depth background. But the basic point is this - Jerome Powell didn't want to lift interest rates too soon and risk unnecessarily crashing the markets and putting a whole bunch of people out of work.

WONG: And that brings us to reason No. 2 - a concern over inequality. When interest rates are low, businesses can borrow and expand more easily. That means a faster recovery, and that is particularly beneficial for low-wage workers who are disproportionately Black and Latino.

WOODS: Bill says this was especially salient for the Fed in the wake of the 2020 Black Lives Matter protests.

NELSON: I think that that led the Fed to redouble their desire to try to do something about unequal incomes.

WONG: Bill's reason No. 3 for the Fed being slow is basically that the Fed fumbled its communication, at least in hindsight. So think back to the early days of the pandemic.

(SOUNDBITE OF ARCHIVED RECORDING)

JEROME POWELL: Good afternoon, everyone. Thanks for joining us.

WONG: An enormous number of people out of work, borders shutting around the world and markets plunging. Here's Jerome Powell around that time.

(SOUNDBITE OF ARCHIVED RECORDING)

POWELL: We're not thinking about raising rates. We're not even thinking about thinking about raising rates.

WONG: Remember - interest rates were basically at zero. And so central banks wanted to reassure markets that they'd stay low for a long time into the future. And to keep credibility, the Fed had to keep true to that, at least for a while.

(SOUNDBITE OF ARCHIVED RECORDING)

POWELL: No rate increase at least through 2022.

WOODS: But then, by June 2021, inflation had shot up to 5%. So Jerome Powell was in this bind. Does he break that promise not to tighten policy and instead nip inflation in the bud? Or does he keep true to the Fed's word that they're going to keep interest rates low for a very long time? And this is where Bill thinks they messed up communication.

NELSON: I think they could have chosen language which provided them more optionality while still being very forceful. But nevertheless, I think, you know, that was - it was understandable that they wanted to be as forceful as they possibly could.

WONG: The Fed had committed to raising interest rates only when the economy reached full employment. But Bill wouldn't have made a promise that explicit. He would have watered it down a little in case something unexpected happened - like runaway inflation.

WOODS: For example. And the fourth factor that Bill cites is one that I think we can all relate to - a belief that normal was just around the corner.

NELSON: I would call it a belief that the future will be like the past. You know, the Fed - their actions are informed by econometric models of what the economy is going to do. And that sounds quite sophisticated and complicated. But the models, in the end, pretty much boil down to saying, we expect things to go back to where they were in the future. And inflation had been at or below 2% for over a decade. And so it was very difficult for those models to reach the conclusion that things were going to do other than come back to 2%.

WOODS: This is Jerome Powell at the time describing what the Fed's projections for inflation would be this year in 2022.

(SOUNDBITE OF ARCHIVED RECORDING)

POWELL: Inflation is expected to drop back toward our longer-run goal, and the median inflation projection falls from 3.4% this year to 2.1% next year and...

WONG: OK. So those projections were a little off.

WOODS: Sadly, they were. A big reason was that the Fed was explaining most of the price rises as temporary pandemic supply shocks to things like car factories and shipping routes. And Bill says that, yeah, a lot of the price rises were temporary supply problems caused by the virus, but that the Fed underestimated the psychology of inflation. Seeing those price rises everywhere means that everyone wants to ask their employer for a pay rise or switch to a job that pays higher. This is called inflation expectations. When people expect prices to rise and rise and rise, that is the worst nightmare for the Fed.

NELSON: And then that becomes permanent inflation. And those shocks are generally unforecastable (ph). And judging that tipping point is extraordinarily difficult.

WONG: Now, Bill's fifth factor is more controversial. It's politics. Jerome Powell was vying for renomination in November of 2021. And the months leading up to that happened to be when it was becoming clear that inflation was going to be a problem. And while we don't claim to know what was going on in Jerome Powell's head at the time, it is fair to say that emphasizing the Fed's role in encouraging jobs was more likely to endear you to the president versus saying you're going to come down like a hawk on inflation and put people out of work. In the weeks leading up to the nomination, inflation was super high at over 6%, and Jerome Powell was sounding like this.

(SOUNDBITE OF ARCHIVED RECORDING)

POWELL: The time for lifting rates and beginning to remove accommodation will depend on the path of the economy. We think we can be patient.

WONG: And in the weeks after his nomination, he was sounding more like this - much more determined to rein in inflation.

(SOUNDBITE OF ARCHIVED RECORDING)

POWELL: We are committed to our price stability goal. We will use our tools both to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched.

WONG: Finally, Bill points to bad luck. In economic speak, that's large, multiple unfixable inflation shocks. To us regular people, that's new coronavirus variants, droughts and floods, plus, of course, the war in Ukraine. It just wasn't a good last 12 months for clearing out tangled supply chains and getting the economy back to normal like we'd hoped.

WOODS: Now, Bill wrote these six main reasons kind of as a bad report card for the Fed last year. But he's more comfortable with the Fed's actions raising rates now.

NELSON: The staff and the policymakers at the Fed are as good as they get. And so I have a lot of confidence in the crew, you know, to bring this off. If it can be done, that's the team that could do it.

WOODS: Bill just wishes they had started sooner.

WONG: We have a link to Bill's full list of reasons why he thinks the Fed was slow to raise rates - the full list at 14 points. Find the show notes at npr.org/indicator.

The show was produced by Nicky Ouellet with engineering from Gilly Moon. It was fact-checked by Catherine Yang. Viet Le is our senior producer. And Kate Concannon edits the show. And THE INDICATOR is a production of NPR.

Copyright © 2022 NPR. All rights reserved. Visit our website terms of use and permissions pages at www.npr.org for further information.

NPR transcripts are created on a rush deadline by an NPR contractor. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of NPR’s programming is the audio record.