The Fed wants to fight inflation without a recession. It’s too late?

The Federal Reserve is poised to lay out a path to quickly withdraw support from the economy at its Wednesday meeting, and while it hopes it can contain inflation without causing a recession, this is far from guaranteed.

The central bank is likely to gently take over the economy will serve as a referendum on its policy approach over the past couple of years, making this a tense time for a Fed that has been criticized for being too slow to acknowledge that the price explosion. America in 2021 was turning into a more serious problem.

Fed chairman Jerome H. Powell and his colleagues are expected to raise interest rates by half a percentage point on Wednesday, which would be the largest increase since 2000. Officials also signaled that they will release a plan to reduce their credit balance. $ 9 trillion sheet as of June, a political move that will further increase financial costs.

This two-pronged push to cool the economy is expected to continue throughout the year – several politicians have said they hope to get rates above 2% by the end of 2022. Taken together, the moves could prove to be more of a retreat. rapid money market. sustained over decades.

The Fed’s response to hot inflation is already having visible effects: the rise in mortgage rates appears to have cooled some homes booming markets, e share prices they are swinging. The months ahead could be volatile for both markets and the economy as the nation sees if the Fed can slow rapid wage growth and price inflation without forcing them so hard that unemployment rises sharply and growth does. contracts.

“The Fed’s task of achieving a soft landing is formidable,” said Megan Greene, chief global economist at the Kroll Institute, a research arm of consulting firm Kroll. “The trick is to cause a slowdown and lean on inflation, without unemployment rising too much: it will be difficult.”

Optimists, including many at the Fed, point out that this is an unusual economy. Job opportunities are plentiful, consumers have accumulated savings reserves and it seems possible that growth will be resilient even if trading conditions slow down a bit.

But many economists have argued that rising cooling prices when labor is in demand and wages are rising could require the Fed to take significant momentum from the labor market. Otherwise, companies will continue to pass the rise in labor costs onto customers by raising prices, and households will maintain their ability to spend thanks to the increase in payroll.

“They need to design some sort of growth recession, something that raises the unemployment rate to ease the pressure on the labor market,” said Donald Kohn, a former Fed vice president who is now at the Brookings Institution. Doing this without stimulating a real flexion is “a narrow path”.

Fed officials cut interest rates to near zero in March 2020 as state and local economies stalled to slow the spread of the coronavirus at the start of the pandemic. They kept them there until March this year, when they raised rates by a quarter of a point.

But the Fed’s fiscal approach was the most widely criticized policy. The Fed began buying large amounts of government-guaranteed debt at the start of the pandemic to calm bond markets. Once conditions stabilized, he bought bonds at a rate of $ 120 billion and continued to buy even as it became clear that the economy was recovering faster than many had anticipated and inflation was high. .

Bond purchases in late 2021 and early 2022, which are what critics tend to focus on, came in part because Mr. Powell and his colleagues initially didn’t think inflation would get any longer. They labeled it “transient” and predicted it would fade on its own, in line with what many private sector forecasters expected at the time.

As supply chain disruptions and labor shortages continued into the fall, pushing prices up for months and driving wages up, central bankers reassessed. but even after they have overturnedit took some time to reduce bond purchases and the Fed did it last purchases in March. As officials preferred to stop buying bonds before raising rates, the delayed one the entire tightening process.

The central bank was trying to balance the risks: it did not want to quickly withdraw support from a healing labor market in response to short-lived inflation in early 2021, and therefore officials did not want to swing markets and undermine their credibility by quickly reversing their budgetary policy. They made to accelerate the process in an effort to be agile.

“In hindsight, there is a really good chance the Fed has started tightening up sooner,” said Karen Dynan, an economist at Harvard Kennedy School and former chief economist at the Department of the Treasury. “It was really hard to judge in real time.”

Nor was Fed policy the only thing that mattered to inflation. Had the Fed started withdrawing political support last year, it could have slowed the housing market faster and laid the groundwork for a slowdown in demand, but it wouldn’t have solved. tangled supply chains or changed the fact that many consumers have more cash on hand than usual after repeated government rescue checks and months spent at home at the onset of the pandemic.

“I think it would look somewhat different,” said Kohn, who was critical of the Fed’s slowness of the economy if he had reacted earlier. “Would it look very different? I do not know.”

However, the gradual shift away from accommodative monetary policy could give inflation time to become a more permanent feature of American life. Once rapid price increases are incorporated, they may prove to be more difficult to eradicate, requiring higher rates and perhaps a more painful rise in unemployment.

For now, in the long run consumer inflation expectations they have remained fairly stable, although short-term expectations have increased. The Fed is moving quickly now to avoid a situation where inflation changes expectations and behavior more lastingly.

James Bullard, the chairman of the Federal Reserve Bank of St. Louis, even suggested that officials might consider a 0.75-point rate hike, although his colleagues have reported little appetite for such a big move in that. encounter.

Michael Feroli, US chief economist at JP Morgan, said in a research note that while “it’s pretty clear this economy doesn’t need stimulating monetary policy,” he didn’t expect the Fed to raise interest rates by that much. , especially since he tended to broadcast his moves in advance.

“But if there’s a time to break the habit, it’s when the credibility of the Fed’s inflation is called into question, and so we don’t erase the possibility of a broader rate move,” he said.

What happens next with inflation and the economy will depend in part on factors beyond central bank control: If supply chains heal and factories recover, rising prices for cars, equipment, sofas and clothes could self-moderate and Fed policies don’t have to do much to slow demand.

Many economists expect inflation at the peak in the months to come, although it is unclear how long it will take before it comes back down 6.6 percent in March reading something more in line with the 2% annual rate the Fed is targeting on average over time, or whether that is possible without the pain of the job market and a recession.

Treasury Secretary Janet L. Yellen, former Fed chairman, summed up the situation so last month: “It’s not an impossible combination. But it will require skill and good luck too.