Fed Holds Interest Rates Near Zero, Expects Temporary Rise in Inflation

April 28, 2021 Updated: April 29, 2021

WASHINGTON—The Federal Reserve announced on April 28 that it would keep U.S. interest rates near zero as the pandemic “continues to weigh on the economy.” The Fed officials expect a temporary spike in inflation due to strong consumer spending as the economy continues to reopen.

Following a two-day meeting of the Federal Open Market Committee (FOMC), the U.S. central bank announced it would hold the federal funds rate at a range of zero to 0.25 percent, in line with expectations.

“Amid progress on vaccinations and strong policy support, indicators of economic activity and employment have strengthened,” the FOMC’s revised statement read.

“The sectors most adversely affected by the pandemic remain weak but have shown improvement. Inflation has risen, largely reflecting transitory factors.”

At the last FOMC meeting in March, the committee unveiled substantial upgrades to its economic forecasts to reflect the progress on vaccinations and the strong fiscal policy support. Despite an acceleration in economic recovery, the Fed officials stated that the pandemic “continues to weigh on the economy, and risks to the economic outlook remain.”

Committee members unanimously agreed to maintain policy measures to support the economy and ensure the flow of credit to households and businesses.

“While the recovery has progressed more quickly than generally expected, it remains uneven and far from complete,” Chairman Jerome Powell said at a post-meeting press conference.

Powell noted the recent spike in inflation and said it would rise further before moderating.

The consumer price index rose 0.6 percent in March, more than expected, with half of the increase driven by a 9.1 percent jump in gasoline prices. Overall consumer prices were up 2.6 percent from a year ago, the fastest pace since August 2018.

The economy would continue to see “upward pressure on prices from the rebound in spending as the economy continues to reopen,” Powell said, “particularly if supply bottlenecks limit how quickly production can respond in the near term.”

“However, these one-time increases in prices are likely to have only transitory effects on inflation,” he said, adding that these spikes would not lead to persistently higher year-over-year inflation.

Economists, including Larry Summers, the former Treasury secretary of President Bill Clinton, raised concerns earlier about President Joe Biden’s $1.9 trillion relief package and warned that excessive government spending could overheat the economy and fuel inflation.

‘The Flood of Liquidity’

The central bank will continue to increase its asset holdings at the current pace, buying at least $80 billion per month in Treasurys and $40 billion in mortgage-backed securities.

Powell reiterated that the Fed would continue to its asset purchase program until it sees “substantial further progress” toward the central bank’s employment and price stability goals.

As a result of the Fed’s measures, business bankruptcies have been “remarkably low,” according to Ed Yardeni, economist and president of Yardeni Research.

“The flood of liquidity provided by the Fed at the start of the pandemic last year averted what could easily have been a credit crunch as terrible as the one that occurred during the Great Financial Crisis,” he stated in a report.

“Instead, corporations have been able to issue lots of bonds and stocks. They’ve refinanced their debts at record-low interest rates and had plenty of money to finance capital spending.”

However, businesses will take a hit if the Biden administration succeeds in raising the corporate tax rate. Yardeni estimates that Biden’s tax increases would reduce S&P 500 earnings per share by $15 next year.

The Fed’s decision about the rates came hours before President Joe Biden’s first address to a joint session of Congress on April 28. Biden is expected to propose his latest package, the American Family Plan, and a series of tax hikes to pay for it.

China’s Digital Yuan

In response to a question about digital currency launched by the Chinese central bank, Powell said that the digital yuan couldn’t replace the dollar as the world’s main reserve currency.

“That’s because of our rule of law, our democratic institutions, which are the best in the world, our economy, our industrious people,” and open capital accounts, he said.

Powell repeated his view that he isn’t concerned about countries like China that move fast in launching a digital currency.

“I am really concerned about getting it right,” he said.

He also noted that China’s digital currency wouldn’t work in the United States.

“It’s one that really allows the government to see every payment for which it is used in real time,” he said.

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