Last year, Fed officials were wary of overreacting to one-time price increases by raising interest rates and cooling the labor market if supply-chain bottlenecks were the primary driver of inflation and were expected to reverse themselves over time. They highlighted how the economy employed millions fewer workers in the first half of 2021 compared to February 2020, just before the pandemic hit the U.S. economy.
Mr. Powell, on the other hand, announced a policy shift in late November, amid signs that the labor market was tightening. He began to express greater concern that demand was stronger than expected, which could fuel broader and longer-term price pressures, even if idiosyncratic increases caused by supply issues were reversed later.
“There’s a real risk now, I believe, that inflation will be more persistent, and…the risk of higher inflation becoming entrenched has increased,” Powell said at a press conference last month.
Mr. Powell stated in prepared testimony for Tuesday’s hearing that the central bank would use its tools “to prevent higher inflation from becoming entrenched.”
Mr. Powell has stated that using pre-pandemic labor market benchmarks to guide policy decisions may no longer be appropriate, providing yet another hint that rate hikes may begin in March.
Fed officials have hinted that they may begin shrinking their asset portfolio soon after raising rates, which would be another form of policy tightening.
Officials are placing more emphasis on the possibility that the aggressive fiscal- and monetary-policy responses to the pandemic over the last two years have altered traditional recessionary dynamics, boosting wage growth that normally takes longer to recover after a downturn.
A sharp increase in home values, stock prices, and other assets has increased wealth for many Americans, fueling stronger demand and potentially allowing some to retire earlier than expected, tightening the labor market. Demand may rise even further if the pandemic subsides, increasing spending on services and prompting more Americans to look for work.
Brisk consumer demand, disrupted supply chains, and various shortages have pushed 12-month inflation to its highest levels in decades. According to the Fed’s preferred measure, core consumer prices, which exclude volatile food and energy categories, were up 4.7 percent year on year in November. That is significantly higher than the Fed’s target of 2%.
However, it is labor market developments, rather than high inflation readings, that have fueled the Fed’s recent shift toward tightening policy much faster than appeared likely last summer.
The unemployment rate, which fell to 3.9 percent in December, is now lower than it was when Mr. Powell became Fed chairman four years ago. Despite the upheaval caused by the pandemic, which increased unemployment to a post-World War II high of 14.7 percent in April 2020.
Four years later, 68 of the 84 lawmakers who voted to confirm Mr. Powell, a Republican, are still in office, evenly divided between the two party caucuses. When President Biden announced Mr. Powell’s reappointment in November, several lawmakers from both parties expressed their support.
Mr. Powell has spent a significant amount of time meeting with elected officials in order to maintain close communication, and he pledged in his testimony Tuesday that if he is confirmed for a second term, he will continue that practice.
Mr. Powell, who has worked in investment banking and private equity, was first nominated for a Fed board seat by President Obama ten years ago. President Trump appointed him chair four years ago.