Fears of recession are rising as the Fed fights inflation

As Americans feel the pressure of rising inflation, fears are growing that a recession is around the corner.

The US economy is running hot, as record job growth, stable consumer demand and intense demand for labor have helped boost the highest inflation in 40 years.

While the economy has recovered far faster than many economists expected, the rate of recovery is putting pressure on the Federal Reserve to take more substantial measures to help curb inflation.

Wendy Edelberg, director of The Hamilton Project and a senior fellow in economic studies at the left-wing Brookings Institution, said the economy is “upside down” given the amount of fiscal stimulus that has been poured into the system to keep it liquid under coronavirus. pandemic.

But to combat the skyrocketing inflation, Edelberg and other economists say a slowdown is crucial.

“So now the question is, how evenly does that deceleration happen?” said Edelberg. “And braking can be painful. So there’s definitely a risk of a recession.”

The Fed’s primary tool for keeping prices stable and the labor market strong is to adjust federal funds rates. When the Fed raises or lowers its base rate range, the borrowing costs of mortgages, credit cards and other loan products typically move in the same direction.

As interest rates rise, consumer and business consumption tends to fall as the cost of borrowing money rises. Higher interest rates also encourage savings, which means less immediate spending in the economy.

After lowering interest rates to near-zero levels in the midst of the beginning of the pandemic, the Fed launched a series of rate hikes in March to bring rising inflation down.

The Fed hopes that higher borrowing costs will slow the economy enough to curb inflation without halting the recovery.

“Our goal is to restore price stability while promoting further long-term expansion and maintaining a strong labor market,” Fed Chairman Jerome Powell said last month, adding that the bank is aiming for a “soft landing” for the economy. , where inflation falls and unemployment persists. ”

Powell, other Fed officials, and some economists believe the U.S. economy is strong enough to withstand rising interest rates without falling into recession or losing jobs. The United States got nearly 1.7 million jobs during the first three months of the year, consumer spending has remained strong, and there are about two vacancies for every unemployed job seeker.

Those who trust the Fed’s handling of inflation believe the bank can keep inflation down while only reducing job openings and the intense need for workers instead of slowing the economy to layoffs.

Yet the Fed is facing severe turbulence as it seeks to steer the recovery to a sustainable pace.

The war in Ukraine, the sanctions against Russia and Moscow’s reaction have led to rapid price increases for oil, petrol, food, important minerals and other important consumer goods already affected by inflation. COVID-19 shutdowns in China have also blocked supply chains, which were already overwhelmed by consumer demand.

Dana M. Peterson, chief economist at The Conference Board, said that Fed rate hikes could help reduce consumer demand for goods and services, pent-up savings, rising wages and heat in the housing market, but that they can do nothing about supply chain dysfunction, COVID -19 shutdowns and the war.

“The driving forces of inflation on the supply side, which include supply chain disruptions and also higher global commodity prices, the Fed can do very little about. Nevertheless, the Fed will raise interest rates,” Peterson said during a Thursday briefing with reporters.

“I do not know how sure the Fed is of anything, but I certainly think they have given up expectations that there will be some sort of natural solution to inflation.”

Economists warn that more needs to be done to tighten monetary policy to cool the economy, which could still mean pain in the coming months for more Americans’ finances.

“When you slow down the economy, inflation will fall,” said Ray Fair, an economics professor at Yale University, adding that this is how the Fed can help lower inflation. “But the cost of it is, of course, slower production growth and higher unemployment.”

And Fair, the emeritus director at the National Bureau of Economic Research (NBER), said his own research suggests the Fed has “have to do a lot” intervention to slow down the economy.

“They have to raise interest rates, for example, by more than just two percentage points if they expect to get much lower inflation,” Fair said. The Fed funds rate is currently in the range of 0.25 to 0.5 percent, and bank officials expect to raise it to around 2 percent by the end of the year.

Some economists fear that inflation may rise too fast for the Fed to slow down without raising interest rates so high as to halt economic growth.

In March, consumer prices rose 1.2 percent, according to data released by the Department of Labor this week. The data also found that prices had risen to 8.5 percent in the past year alone, marking the highest annual increase in about four decades.

Americans saw prices rise in a number of areas, from food to gasoline and transportation, as the war between Ukraine and Russia helped exacerbate the nation’s persistent inflation problem.

Fair, whose bureau is often called upon to measure recessions, said the NBER’s defines such an event as rough, but not complete, “two consecutive quarters of negative real GDP growth.”

Recent weeks have seen reports of institutions like Bank of America warning of recession shocks. A recent study by The Wall Street Journal showed that several economists are also changing their stance on the chances of a recession, finding that forecasters “on average put the likelihood of the economy in recession sometime in the next 12 months at 28 percent , “compared to 18 percent in January.

In an interview, Desmond Lachman, a senior fellow at the right-wing American Enterprise Institute, said he feels a recession is likely.

“To [the Fed] to get inflation out of the system, they will have to tighten policies and that will produce a recession, ā€¯Lachman said.

But others believe the Fed may have to argue that higher inflation may be in place for a little longer as the central bank continues to slow the economy.

“They will also have to recognize that they may not return to a 3 percent or 2 percent (annual inflation) target any time soon,” Peterson said, arguing that such an attempt “would essentially drive the US economy into recession. ”

Leave a Comment