U.S. Federal Reserve's Jerome Powell issues caution on housing, rejects inflation warnings

Even though it came on the same day U.S. President Joe Biden was announcing another $1.8 trillion in spending, Federal Reserve Chair Jerome Powell rejected worries that a multitrillion-dollar injection of cash into the economy would spur a new round of inflation.

While offeringwhat could be read as a warning for Canada on the economic dangers of a house price meltdown, the world's most influential central banker decided notto follow the Bank of Canada's lead on reducing monetary stimulus although some have suggested that he should have.

Last year, as the U.S. economy began to pull out of the depths of the pandemic recession, Powell famously said he was not even "thinking about thinking about" raising interest rates, and at Wednesday's news conference, the first question from reporters was a demandto know whether that had changed. Was now the time to at least talk abouttalking about it?

Powell's response was definitive.

"No, it is not time yet," he told reporters at the virtual news conference. "We've said we would let the public know when it was time to have that conversation, and wesaid we'd do that well in advance of any actual decision to taper our asset purchases."

Stimulus must end, but when?

That flies in the face of high-level advice that the Fed should begin showing markets as Bank of Canada GovernorTiff Macklem did last week and thatthe current level of extraordinary stimulus must come to an end sooner than many have expected.

A growing number of commentators and a growing number of reports in the financial press suggest that a surge of spending flowing into the hands of poorer Americans, a mass of savings by consumers, plus the lowest interest rates in historycould help send prices soaring before the world's central banks could slow down inflation.

"The Fed should seriously consider following the Bank of Canada's example by initiating a gradual and careful retreat,"wrote Mohamed A. El-Erian, chief economic adviser at financial services giantAllianz,in a Bloomberg commentary before Powell spoke.

"The longer it takes to do so, the harder it will be to pull off an eventual normalization without risking both significant market volatility and damaging what should and must be a durable and inclusive economic recovery."

El-Erian is not the only one to have warned Powell to take action sooner rather than later. LawrenceSummers, a well-known U.S. economist and adviser to Bill Clinton when he was president, has worried publicly that the economy could be heading into a period of inflationary turmoil similar to the 1970s, when interest rates approached 20 per cent as central bankers hiked them repeatedly in an effort to get wage and price inflation under control.

"As I look at $3 trillion of stimulus, $2 trillion of savings overhang, a major acceleration coming from COVID in the rear-view mirror, rates expected by the Federal Reserve to be at zero for three years even in a booming economy, record growth this year, major expansion of the Fed balance sheetand much new fiscal stimulus to come,I'm worried,"Summers said last month.

One of the worries expressed at the Powell news conference referred to the well-knownlag between the time a central bank begins to raise rates and the impact on prices. In the past, research by the Bank of England has suggested that the lag could be as long as two years before hikes take full effect.

The cost of avoiding a tantrum

But as El-Erian explained, one reason not to taper right now is afear by some of the destabilizing impact of withdrawing stimulus just as Biden is struggling to get the economy back on track. It might be an attempt to prevent a replay of the so-called taper tantrumin 2013, when a Powellpredecessor, Ben Bernanke,tried to reduce bond purchases leadingto howls of outrage as bond prices fell and yields rose.

Powell seemed more careful thanusual in responding to questions, often flipping through a book of notes to pre-written answers rather than speaking off the cuff. Even though he stated clearly that the central bank would have to sell off its stock of bonds eventually, he put no end point on stimulus. That said, he made no specific reference to holding rates near zero until2024, something he said as recently as March.

One comment Powell made will be close to the hearts of Canadians worried about the state of this country's soaring property markets. Asked about housing in the U.S., he said that while a sharp rise in prices was not an "unalloyed good,"the bank would be watchingcarefully even if it was no immediate cause for concern. However, that might not be the same everywhere.

"So many of the financial crack-ups in all ... Western countries that have happened in the last 30 years have been around housing," he said.

WATCH | How the pandemic is raising prices on some goods in Canada:

How the pandemic is raising prices on some goods

3 years ago

Duration 1:44

The pandemic has led to skyrocketing costs for raw materials, particularly lumber. And that translates to higher prices on everything from mattresses to diapers.

Powell said that while the bank would be willing to allow short-term inflation to climb higher than usual until the U.S. economy was back on track, the Federal Reserve would be willing to use the tools at its disposal tools that include higher interest rates to keep long-term inflation at twoper cent.

The concern expressed by critics like Summers is whether the Fed will be forced to hike rates more sharply than would be good for a still-recovering economyif rising prices turn out not to be as transitory as Powell hopes.

Folllow Don Pittis on Twitter @don_pittis