Fed’s future credit tightening carries recession, political risks

WASHINGTON—Federal Reserve policymakers have abandoned the notion that they can bring the U.S. economy in for the perfect soft landing—when inflation settles at its target, growth throttles back smoothly to trend and monetary policy shifts to neutral.

Instead, they’re prepared to step on the brakes.

“Nearly all” Fed officials believe that the central bank will have to restrict the economy by pushing interest rates above their long-run equilibrium level to achieve their aims, according to the minutes of their Dec. 12-13 meeting released this week. The central bank is more likely to make a policy mistake and inadvertently push the economy into a recession if it is actively seeking to curb credit and increase unemployment, rather than just removing monetary accommodation from the financial system, as it is now. Striking the right balance may present political risks, too. That challenge will fall to Fed Governor Jerome Powell, whom President Donald Trump chose to replace Chair Janet Yellen when her term ends Feb. 3. Efforts to slow the economy—to effectively put people out of work so inflation doesn’t run out of control—could run counter to the employment and economic growth goals of the administration. In a speech in January 2016, New York Fed President William Dudley noted that the economy historically “has always ended up in a fullblown recession” whenever unemployment has risen by more than 0.3 to 0.4 percentage points.

Fed officials forecast that the unemployment rate will fall to 3.9 percent at the end of this year, and then stay there, before inching up to 4 percent at the close of 2020. That would still be below November’s 4.1 percent rate and would be under the 4.6 percent level they reckon is equivalent to full employment. The central bank has pushed unemployment so far below the setting it considers sustainable in the long term because of the difficulty it’s had lifting inflation to its 2 percent goal. Since the target was adopted in January 2012, inflation has been below the central bank’s objective more than 90 percent of the time. In November, the personal consumption expenditures price index was 1.8 percent higher than a year earlier. So far, the amount of tightening envisaged by U.S. central bankers is not that big. Policymakers expect the federal funds rate to rise to 3.1 percent at the end of 2020, a bit above their longer-run neutral rate of 2.8 percent, according to their median forecasts.