Federal Reserve officials are set to raise interest rates to control inflation, but the return to normal they had hoped to see remains painfully elusive.
When Federal Reserve officials raised interest rates on Wednesday, they will do so amid an unfortunate economic reality: Many of the inflationary pressures they had long assumed would dissipate have instead lingered, and some are getting worse.
Central bankers have consistently underestimated how high inflation would rise, and how long it would last, as the economy has surged back from pandemic shutdowns. They will release a fresh set of quarterly economic projections Wednesday, in which they are likely to raise their inflation forecasts for the fifth time in a row.
Like many private-sector forecasters, the Fed misjudged how strong American demand would be for goods and how long that demand would help to keep global supply chains running behind schedule, forces that have combined to push up consumer prices.
Officials spent much of the past year expecting a relatively quick return to some pandemic-infused version of normality, but backlogged factories, crowded ports and overburdened trucking companies are still failing to catch up. Repeated waves of the virus have exacerbated the problems, which along with rising wages and services prices have sent inflation higher. Consumer price gains hit a new 40-year high in February, pushed up by rising prices for food, rent, and gas.
Now, as Fed officials prepare to begin a series of interest rate increases to try to bring inflation under control, they once again appear to be aiming at a moving target. Supply chains that showed signs of improvement in January and February are being thrown further into disarray by the Russian invasion of Ukraine and sweeping lockdowns in China, developments that promise to lengthen delivery times and add to prices.
The war, at the nexus of Europe and Asia, has scrambled flights and ocean shipments threatened supplies of palladium, nickel, and wheat, and sent energy prices soaring, further fueling inflation. Automakers have shuttered factories due to a shortage of parts, and Russia has answered back to sweeping sanctions imposed by the West by announcing its own plans for export controls.
In recent days, Chinese cities and provinces have imposed extensive lockdowns to try to stop the spread of the Omicron variant. Shenzhen, a hub of electronics manufacturing and a vital port that is home to 17 million people, announced a lockdown on Sunday night for seven days. Foxconn, a Taiwanese electronics firm that supplies Apple from factories there, said it would suspend operations.
Further restrictions in China, home to more than a quarter of global manufacturing, are likely to reverberate through already-tangled supply chains and exacerbate inflation.
“The question is whether this is going to be bad or very bad,” Phil Levy, chief economist at the logistics company FlexPort, said of the Chinese shutdowns in particular. He noted that this disruption came at a time when shipping delays were already extreme.
“If things get gummed up there, it will reverberate through the whole system,” he said, adding that it matters how long and how sweeping the shutdown proves. “These problems just build.”
Mary Lovely, a senior fellow at the Peterson Institute for International Economics, said it was “hard to overstate” the importance of Shenzhen and its surrounding area for electronics, as well as for other industries, like metals, furniture, and paper products.
“I think it’s definitely going to have an effect on supply chains,” she said. She added that she expected those pressures to translate more readily into increased prices than they had earlier in the pandemic.
“Now we’re in a period with higher inflation, I think that suppliers may find it easier to pass those costs along, or take this opportunity to raise prices,” Ms. Lovely said.
Fed officials have held interest rates near zero since March 2020 and are expected to raise them for the first time since 2018 on Wednesday. By making money more expensive to borrow and spend, the Fed is hoping to cool down demand and beat back inflation — helping conditions to even out at a time when a return to “normal” has been painfully, and consistently, elusive.
Fed policymakers and Wall Street researchers alike thought that prices would fade as consumers began shifting their spending from imported goods back to movies, vacations, and restaurants. That shift would help factories and shipping routes catch up with surging demand, and would come as used car prices — which spiked last year — moderated. Those trends either haven’t happened, or they have been canceled out by increases in the prices of other products and services.
Jason Furman, an economist at Harvard University, said many forecasters had been doing what investors sometimes refer to as “pricing to perfection”: assuming that everything is going to go well, even if that is not the most likely outcome.
“You can look at the individual items: There’s been a lot of, what if inflation in X, Y, Z goes down,” he said. “And not: What if inflation in A, B, C goes up?”
Many of the factors prompting economists to mark up their inflation forecasts now are not even tied to scrambled supply chains.
Matthew Luzzetti, the chief U.S. economist at Deutsche Bank, recently revised up his inflation projections because rent costs are rising so rapidly in the Consumer Price Index. Between that and wage growth, he thinks high inflation will last unless the Fed intervenes.
“For a while, inflation forecasters had been anticipating that the goods side of things would return to more normal dynamics” just as service prices, like rent, began to increase, he said. Services prices have indeed picked up, but normalization in good prices keeps getting “pushed out.”
Consumers continue to spend a bigger share of their budgets on goods instead of services — purchases like travel and manicures — compared with before the pandemic. That has meant global producers are still struggling to keep up with demand. Even potentially short-lived disruptions, like the ones now taking place in China, can add to a snowball of delays and shortages.
Data released this month showed that the U.S. trade deficit hit a record in January, the height of the Omicron wave, in part because of surging imports of cars and energy. The average time to ship a container from a Chinese factory to a U.S. warehouse had stretched to 82 days in February, according to Freightos, a logistics platform, up from 45 days two years before.
In many ways, the events of the past few years have been so unusual that few if any forecasters correctly predicted all of them. And Fed officials have acknowledged that they misjudged inflation last year, partly because they expected supply chains to recover more quickly.
They are now striking a more wary tone.
Jerome H. Powell, the Fed chair, told Congress earlier this month that the war in Ukraine was “not going to help at all with supply chains.”
“We haven’t seen much relief on the supply side,” he noted, explaining that he and his colleagues had been waiting for the strains to ease.
Mr. Powell predicted that as the Fed raises interest rates this year, it will help to cool off demand for car loans and mortgages, weakening spending in the economy and giving companies some room to catch up with demand. Central bankers are hoping that at the same time, the economy is “going back to normal” in terms of supply chains and the breakdown between goods and services, he said.
Even so, he acknowledged that the Fed stands ready to act more aggressively if that doesn’t happen.
“We hope we’re getting help on the inflation front from a bunch of things,” Mr. Powell said. “In any case, we do have the responsibility to generate price stability, and we will use our tools to do that, over time.”