The Federal Reserve is ready to pave the way for a quick withdrawal of support from the economy at its meeting on Wednesday – and while it hopes it can curb inflation without causing a recession, this is far from guaranteed.
Whether the central bank can gently stop the economy is likely to serve as a referendum on its political approach over the past two years, making it a tense moment for the Fed, which has been criticized for being too slow to recognize that rising prices in America in 2021 it is becoming 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, the largest increase since 2000. Officials also signaled a plan to cut a 9 trillion balance sheet dollars sheet starting in June, a policy move that will further increase borrowing costs.
This push on two fronts to cool the economy is expected to continue throughout the year: Several politicians have said they hope to reach interest rates above 2 percent by the end of 2022. Taken together, these moves could be the fastest withdrawal. cash support for decades.
The Fed’s response to hot inflation is already having visible effects: rising mortgage rates appear to be cooling some booming housing markets and stock prices are fluctuating. The coming months could be volatile for both markets and the economy as the nation sees if the Fed can slow wage growth and price inflation without limiting it so much that unemployment jumps sharply and growth shrinks. .
“The task the Fed has to make a soft landing is a huge one,” said Megan Green, chief global economist at the Kroll Institute, a research division of consulting firm Kroll. “The key is to slow down and lean on inflation without rising unemployment too much – it will be difficult.”
Optimists, including many in the Fed, say this is an unusual economy. Job vacancies are plentiful, consumers have built up savings buffers, and it seems possible that growth will be sustainable, even when business conditions slow down somewhat.
Find out inflation in the United States
But many economists argue that the cooling downward price, when labor is sought and wages are rising, may force the Fed to set aside significant money from the labor market. Otherwise, firms will continue to pass on rising labor costs to customers by raising prices, and households will maintain their ability to spend thanks to rising wages.
“They need to create some kind of growth recession – something that raises unemployment to take away the pressure on the labor market,” said Donald Cohn, a former Fed vice president who is now at the Brookings Institution. Doing this without encouraging a direct decline is a “narrow path”.
Fed officials cut interest rates to almost zero in March 2020 as state and local economies shut down to slow the spread of the coronavirus at the start of the pandemic. They were kept there until March this year, when they raised interest rates by a quarter.
But the Fed’s balance sheet approach is the more widely criticized policy. The Fed began buying government-backed debt in large quantities at the start of the pandemic to calm bond markets. Once conditions settled, she bought $ 120 billion worth of bonds and continued to buy, even as it became clear that the economy was recovering faster than many expected and inflation was high.
The bond purchases in late 2021 and early 2022, which critics tend to focus on, came in part because Mr Powell and his colleagues initially did not think inflation would last longer. They called it “transient” and predicted it would fade on its own – in line with what many private sector forecasters expected at the time.
When supply chain disruptions and labor shortages continued in the fall, raising prices for months and raising wages, central bankers overestimated. But even after they turned around, it took time to cut bond buying and the Fed made its last purchases in March. As employees preferred to stop buying bonds before raising interest rates, this slowed down the whole tightening process.
The central bank was trying to balance risks: it did not want to quickly withdraw support from the treating labor market in response to short-term inflation earlier in 2021 on their balance sheet policy. They speeded up the process in an attempt to be nimble.
“Looking back, there’s a really good chance the Fed will start tightening sooner,” said Karen Dynan, an economist at Harvard Kennedy School and a former chief economist at the Treasury Department. “It was really hard to judge in real time.”
Nor was the Fed’s policy the only thing that mattered to inflation. If the Fed began withdrawing support for the policy last year, it could have slowed the housing market faster and created the ground for slower demand, but it would not fix tangled supply chains or change the fact that many consumers have more money. available than usual after repeated government relief checks and months spent at home at the start of the pandemic.
Frequently asked questions about inflation
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What is inflation? Inflation is a loss of purchasing power over time, which means that your dollar will not go as far tomorrow as it does today. It is usually expressed as an annual change in the prices of everyday goods and services such as food, furniture, clothing, transport and toys.
What causes inflation? This may be a result of growing consumer demand. But inflation can also rise and fall on the basis of developments that have little to do with economic conditions, such as limited oil production and supply chain problems.
Is inflation bad? Depends on the circumstances. Rapid price increases lead to problems, but moderate price gains can lead to higher wages and job growth.
Can inflation affect the stock market? Rapid inflation usually creates problems for stocks. Financial assets generally performed poorly during the inflation boom, while tangible assets such as houses maintained their value better.
“I think it will look a little different,” said Mr Cohn, who criticized the Fed’s slowness for the economy if it reacted earlier. “It will look very different? I do not know.”
Yet a gradual reorientation from easy monetary policy may give time for inflation to become a more enduring feature of American life. Once rapid price increases are embedded, they may be more difficult to eradicate, requiring higher rates and possibly more painful increases in unemployment.
So far, long-term expectations for consumer inflation have remained relatively stable, although short-term expectations have increased. The Fed is moving fast now to avoid a situation where inflation changes expectations and behavior more permanently.
James Bullard, president of the Federal Reserve Bank of St. Louis, even suggested that officials could consider raising the interest rate by 0.75 points – although his colleagues have signaled that they do not have much appetite for such a big move at this meeting.
Michael Ferroli, the U.S. chief economist at JP Morgan, said in a research note that while “it’s pretty clear that this economy doesn’t need a stimulus monetary policy,” he didn’t expect the Fed to raise interest rates so much, especially because it she was inclined to broadcast her moves some time ago.
“But if there’s time to give up the habit, it’s when the Fed’s confidence in inflation is called into question, so we don’t rule out the possibility of more interest rates,” he said.
What happens next with inflation and the economy will depend in part on factors that are far beyond central bank control: if supply chains strengthen and factories catch up, rising prices for cars, equipment, sofas and clothing could fall you and the Fed’s policies alone won’t have to do much to slow demand.
Many economists expect inflation to peak in the coming months, although it’s unclear how long it will take to return from 6.6 percent in March to more than the 2 percent annual rate the Fed is targeting on average. or whether this is possible without labor market pain and recession.
Finance Minister Janet L. Yellen, a former Fed chairman, summed up the situation last month: “This is not an impossible combination. But it will take skill as well as luck. ”
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