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Light At End Of Tunnel? Fed Sees Faster Economic Growth, With Only Modest Inflation

Fed Chair Jerome Powell testifies before a House Financial Services Committee hearing in Washington on Dec. 2, 2020. The Fed issued new economic forecasts on Wednesday at the end of its two-day meeting.
Jim Lo Scalzo
Fed Chair Jerome Powell testifies before a House Financial Services Committee hearing in Washington on Dec. 2, 2020. The Fed issued new economic forecasts on Wednesday at the end of its two-day meeting.

The Federal Reserve expects the U.S. economy to grow faster this year, although it still expects only a modest uptick in inflation.

The central bank issued its new forecast at the end of a two-day meeting. It comes as the public health outlook is improving and after Congress approved trillions of dollars in federal spending to help the country recover from the coronavirus pandemic.

"The recovery has been faster than we expected," Fed chairman Jerome Powell told reporters. "Part of that just is it's very hard to predict, given we've never seen an event like this. But part of it is just the strength of the fiscal response, which I think will look good over the years."

Investors welcomed the Fed's comments. The Dow Jones Industrial Average rose 189 points to close above 33,000 for the first time. The broader S&P 500 index also closed at a record high.

Despite the more bullish forecast, the central bank echoed public health officials in cautioning that the pandemic is far from over.

The Fed still plans to keep interest rates near zero for an extended period, helping support the economy until the job market is fully recovered and inflation is on track to moderately exceed 2%. Several participants in the meeting suggested that could happen in 2022 — up from just one who thought so in December.

"The path of the economy will depend significantly on the course of the virus, including progress on vaccinations," the Fed said in a statement. "The ongoing public health crisis continues to weigh on economic activity, employment, and inflation, and poses considerable risks to the economic outlook."

A forecast released Wednesday shows Fed officials now expect the economy to grow at a rate of 6.5% this year, up from 4.2% that was projected in December.

Unemployment is now expected to fall to 4.5% by year's end. That's an improvement from the 5% unemployment rate that was predicted three months ago.

Fed officials have cautioned that the headline unemployment rate understates the damage the pandemic has done to the labor market, since it doesn't include millions of people who have dropped out of the workforce.

And despite warnings from some economists that a surge of new spending could trigger a spike in inflation, the Fed is predicting only a modest rise in consumer prices.

Fed officials said they anticipate inflation of 2.4% by the end of this year — up from the 1.8% inflation rate they predicted in December. Excluding volatile food and energy prices, inflation is expected to be 2.2%.

For most of the last decade, inflation has fallen short of the Fed's 2% target. Prices of some goods are likely to jump more than that this year, especially when compared to the early months of the pandemic when prices were depressed. But Fed officials say any increase is likely to be temporary, and not a sign that runaway inflation is at hand. By 2022, inflation is expected to fall back to 2%.

"You can only go out to dinner once per night, but a lot of people can go out to dinner," Powell said. "It will turn out to be a one-time sort of bulge in prices but it won't change inflation going forward."

Since mid-December, when the Fed issued its previous set of forecasts, Congress has passed two big pandemic relief bills, totaling $2.8 trillion in federal spending. The measures include direct cash payments to most Americans as well as expanded unemployment benefits.

That's expected to boost consumer spending — a key driver of the broader economy.

At the same time, the decline in new coronavirus infections and the spread of vaccinations should allow more opportunities later this year for travel, entertainment and other forms of spending that have been largely off-limits during the pandemic.

New infections have fallen sharply since January, although they remain elevated, with nearly 54,000 people testing positive on Tuesday. The pace of vaccinations has been ramping up to more than 2 million each day.

President Biden has said he expects to have sufficient COVID vaccine available for all adults in the country by the end of May.

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Scott Horsley is NPR's Chief Economics Correspondent. He reports on ups and downs in the national economy as well as fault lines between booming and busting communities.