Bank of America says the Fed is playing with fire by downplaying inflation and needs a new playbook

Published Thu, Oct 21 20216:18 AM EDTUpdated Thu, Oct 21 20217:47 AM EDT

Federal Reserve officials could be placing too much emphasis on the past when trying to guide the U.S. economy into the future, according to a Bank of America analysis. The Fed is effectively "fighting the last war," BofA global economist Ethan Harris said, referencing a term that implies officials are looking over their shoulder at previous economic cycles rather than focusing on the unique qualities of the current one. In this case, the Fed is battling an enemy it hasn't seen in decades: persistent inflation that has been driven by factors unique to the Covid-19 pandemic, including supply chain bottlenecks, uncommonly high demand for goods over services and pervasive labor shortages. But rather than trying to tamp down inflation, the Fed has been encouraging it . The central bank last year adopted a new policy regime in which it will tolerate higher levels of inflation in the interest of promoting full and inclusive employment. That has come after more than a decade of falling short of its 2% goal in a climate of an aging workforce, reduced productivity and greater automation. Harris, though, thinks the Fed is too centered on its failures of the past rather than the issue ahead — that inflation may not be as transitory as the policymakers think . "We have never felt that the last cyclical recovery was a good template for the current recovery," the economist wrote. "There is a growing risk that the Fed is forced to make a major policy pivot sometime in the next two years." Under the current policy outline, the Fed soon will begin slowly tapering the amount of monetary juice it's been providing to the economy through its monthly bond purchases. At some point after that process is completed, it would then begin slowly raising interest rates back to a more normal position. But that relies heavily on keeping inflation in check while unemployment goes down. The Fed has a history of having to backtrack on policy when things don't go according to plan. "History shows that a soft landing is very hard to pull off when the Fed is fighting relatively embedded inflation," Harris said. "Moreover, fighting inflation puts at risk t