The Federal Reserve is debating when and how to slow its huge bond purchases, the first step in moving away from its emergency stance as the economy rebounds from the pandemic. As it does, the hole that the coronavirus blew through the labor market looms large.
The reasons to withdraw support soon are obvious. Growth is coming in strong, bolstered by vast government spending. Inflation has heated up, and while that is expected to be a temporary situation, the increase in prices is surprisingly strong.
But the jobs situation is another story. About 6.8 million jobs are missing from employer payrolls compared with February 2020.
The central bank has every reason to expect the economy to continue healing once it slows (or even stops) the bond buying. Asset prices may fall a little bit, and longer-term interest rates might rise slightly, but the Fed’s policy rate is still set at rock bottom, which should keep borrowing costs relatively low. Government spending continues to trickle out into the economy. Many consumers are flush with savings, and eagerly spending them.
The key for Jerome H. Powell, the Fed chair, and his colleagues is to avoid tanking the economy by surprising investors and causing markets to gyrate, credit to dry up and growth to pull back more abruptly than planned.
The state of the job market is a particularly good reason to proceed carefully. If the Fed accidentally sends an overly aggressive signal to markets, causing financial conditions to become too restrictive when millions are still in need of new positions, it could make for a long road back to full employment.
The risk looms especially large as a coronavirus variant causes cases to surge in many countries, including the United States. While it is still unclear how much of a hurdle the Delta variant poses to growth, it has underlined that the pandemic is a persistent threat.
For now, the Fed is being careful to broadcast every incremental step as it debates when and how to begin tiptoeing away from its policy support, something it wants to do only after the economy has made “substantial” further progress. The idea is that a constant drip of communication will prevent any market-rocking surprises.
And the central bank has set out an even more ambitious, and more patient, goal when it comes to interest rates. Barring some big surprise in which financial risks or inflation bubble up dangerously, officials want to see the job market return to maximum employment before lifting borrowing costs.
“They’d like to wait,” said Kathy Bostjancic, chief U.S. financial economist at Oxford Economics. She explained that officials were weighing the need to keep longer-run inflation under wraps against the many jobs still missing — and hoping that price pressures proved short-lived.
“They’re banking on the T-word,” Ms. Bostjancic said. “Transient.”
Yet when that “full employment” goal will be met is a major unknown. Many workers have retired since the start of the pandemic, and it is not clear whether they will return to work even if opportunities are plentiful.
But the participation rate for prime-age workers — the share of people between the ages of 25 and 54 who are working or actively looking for jobs — has fallen precipitously since last year, and Fed officials are hoping to see that figure recover. Lingering child care issues and pandemic nervousness may be keeping would-be workers at home.
The Fed is trying to wait and see what the job market can do.
“It would be a mistake to act prematurely,” Mr. Powell told lawmakers recently. “At a certain point the risks may flip, but right now the risks to me are clear.”