Fed’s aggressive rate hikes raise likelihood of recession
WASHINGTON – Federal Reserve Chair Jerome Powell has pledged to do whatever it takes to curb inflation, now raging at a four-decade high and defying the Fed’s efforts so far to tame it.
Increasingly, it seems, doing so might require the one painful thing the Fed has sought to avoid: a recession.
A worse-than-expected inflation report for May – consumer prices rocketed up 8.6% from a year earlier, the biggest jump since 1981 – helped spur the Fed to raise its benchmark interest rate by three-quarters of a point Wednesday.
Not since 1994 has the central bank raised its key rate by that much all at once. And until Friday’s nasty inflation report, traders and economists had expected a rate hike of just half a percentage point Wednesday. What’s more, several more hikes are coming.
The “soft landing” the Fed has hoped to achieve – slowing inflation to its 2% goal without derailing the economy – is becoming both trickier and riskier than Powell had bargained for. Each rate hike means higher borrowing costs for consumers and businesses. And each time would-be borrowers find loan rates prohibitively expensive, the resulting drop in spending weakens confidence, job growth and overall economic vigor.
“There’s a path for us to get there,” Powell said Wednesday, referring to a soft landing. “It’s not getting easier. It’s getting more challenging.”
It was always going to be tough: The Fed hasn’t managed to engineer a soft landing since the mid-1990s. And Powell’s Fed, which was slow to recognize the depth of the inflation threat, is now having to play catch-up with an aggressive series of rate increases.
“They are telling you: ‘We will do whatever it takes to bring inflation to 2%,’ ” said Simona Mocuta, chief economist at State Street Global Advisors. “I hope the (inflation) data won’t require them to do whatever they’re willing to do. There will be a cost.”
In Mocuta’s view, the risk of a recession is now probably 50-50.
“It’s not like there’s no way you can avoid it,” she said. “But it’s going to be hard to avoid it.”
The Fed itself acknowledges that higher rates will inflict some damage, though it doesn’t foresee a recession: On Wednesday, the Fed predicted that the economy will grow about 1.7% this year, a sharp downgrade from the 2.8% growth it had forecast in March. And it expects unemployment to average a still-low 3.7% at year’s end.
But speaking at a news conference Wednesday, Powell rejected any notion that the Fed must inevitably cause a recession as the price of taming inflation.
“We’re not trying to induce a recession,” he said. “Let’s be clear about that.”
Economic history suggests, though, that aggressive, growth-killing rate hikes could be necessary to finally control inflation. And typically, that is a prescription for a recession.
Indeed, since 1955 every time inflation ran hotter than 4% and unemployment fell below 5%, the economy has tumbled into recession within two years, according to a paper published this year by former Treasury Secretary Lawrence Summers and his Harvard University colleague Alex Domash. The U.S. jobless rate is now 3.6%, and inflation has topped 8% every month since March.
Inflation in the United States, which had been under control since the early 1980s, resurged with a vengeance just over a year ago, largely a consequence of the economy’s unexpectedly robust recovery from the pandemic recession. The rebound caught businesses by surprise and led to shortages, delayed shipments – and higher prices.
President Joe Biden’s $1.9 trillion stimulus program added heat in March 2021 to an economy that was already warmed up. So did the Fed’s decision to continue the easy-money policies – keeping short-term rates at zero and pumping money into the economy by buying bonds – it had adopted two years ago to guide the economy through the pandemic.