By Howard Schneider

WASHINGTON, (Reuters) – The U.S. Federal Reserve has been trying to run a hot economy. It is now in historical territory with a high unemployment rate and inflation levels that have prompted a policy response.

According to data released Friday, the Consumer Price Index (November) saw its highest annual growth in 39 years. These signs indicate that inflation pressures are increasing and that policymakers will be likely to raise inflation projections at next week’s meeting. They have previously been running late on actual results.

It could lead to a change in policy. Officials may accelerate their plans for ending bondbuying, and many analysts believe that it will indicate that rate rises may occur sooner than predicted.

According to past Fed standards, the unemployment rate has also been flashing in red. Since the mid 1940s, the 4.2% rate that was reached in November only surpassed 20%. This includes four periods of low unemployment, which included the 2010s and the Fed increasing rates each time.

2020 was the year that the central bank decided that inflation was less risky and that they would try to extract more jobs from an economy which it believes has changed fundamentally since the inflation panics of 1980s. That conclusion is currently being evaluated in real time.

Glenn Hubbard (ex-chair of the Council of Economic Advisers, President George Bush) said that they are “behind the curve” and was a Columbia University economist.

Hubbard stated that the Fed’s approach to labor market indicators, such as the participation rate, would drive them back to pre-pandemic levels. However, Hubbard warned that “running the economy hot…is risky” if the goal is to counter structural economic forces like demographics, which aren’t responding quickly to central bank policies.

SEARCHING FOR REAL WAGE OPTIONS

Fed officials believe inflation will continue to fall on its own. However, they are preparing to adjust policy so that interest rates can rise sooner than expected next year.

Jerome Powell, Fed Chair, and other policymakers are trying to refute comparisons with the 1980s years when high inflation impacted living standards. However, recent price hikes pose a similar kind of political dilemma.

Wages are increasing as employers try to fill vacant jobs during a time of pandemic unemployment. Those who have jobs are able to take advantage of job opportunities to get higher wages and are less likely to leave.

Yet, once inflation is taken into account, wages have declined for nine out of the last 11 months. The growth rate in real wages has remained steady at the level seen before the pandemic.

The Oval Office has been made aware of this fact by President Joe Biden and the Democratic Party, who face a potential difficult mid-term electoral map in 2019. His approval ratings have also taken a dive due to rising costs.

Biden made Friday’s statement stating that the key price points for gasoline and automobiles are already declining. He also stated that steps being taken by his administration will help to reduce inflation.

Biden noted that “Price rises continue to squeeze families’ budgets.” “We’re making significant progress against pandemic-related supply chain challenges that increase the cost of goods being on shelves. And I expect even more in the coming weeks.”

Next up: THE FED

While the strong CPI figures for November were anticipated, it still “only reinforce the case for faster asset purchase tapering” at the Fed’s meeting next week. Rubela Farooqi is chief U.S. economist of High Frequency Economic. More important than any message from Chair Powell on future tightening policy will be the one that he delivers.

Powell will use this message to defend why this time is different.

There is one explanation for the pandemic. In terms of speed and reach, the 2020 shock to the American economy was unparalleled. The reopening has also been far faster than the 2007-2009 recession’s slow recovery. This has created problems.

The result is inflation. Global supply chains are trying to meet unprecedented consumer demand in the United States. However, this was driven also by another historic anomaly, personal incomes which rose despite huge unemployment.

However, the Fed’s response was equally extraordinary. In November, unemployment is close to the 4% mark that Fed policymakers see as sustainable in the long term.

The Fed has effectively set a lower limit of 3.5% unemployment for the Fed.

In 2012, policymakers published quarterly economic projections. The median unemployment rate has never fallen below 3.5%, but it was only 3.45%. Since January 1948, data shows that the unemployment rate fell below 3.5% only 41 times in 887 months. This was during the jobs boom in the 1950s and 1960s.

The central bank wants to locate a sweet spot, which has proven difficult to find. It will be able to bring inflation down to lower levels, while still allowing for the recovery of the labor force.

This low level of unemployment has not, to my knowledge, ended in a good way.