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

The Federal Reserve at its meeting on Wednesday is set to work out a way to swiftly withdraw support from the economy — and hopes it can control inflation without a recession are far from guaranteed.

Whether the central bank can slowly unload the economy is likely to serve as a referendum on its policy approach over the past two years, making it a tense moment for a Fed that has too much to criticize. There has been criticism that the US 2021 price was ripped off. turning into a more serious problem.

Fed Chairman, Jerome H. Powell and his colleagues expect interest rates to rise by half a percentage point on Wednesday, the biggest increase since 2000. Officials have also indicated they will release a plan to reduce their $9 trillion balance. The sheet is due to begin in June, a policy move that will further push up borrowing costs.

The two-front push to cool the economy is expected to continue throughout the year: Many policymakers have said they expect a rate above 2 per cent by the end of 2022. Taken together, this move could prove to be the fastest withdrawal of monetary support in decades.

The Fed’s response to hot inflation is already showing its effects: climbing mortgage rates are cooling some fast-moving housing markets, and stock prices are faltering. The coming months could be volatile for both markets and the economy as the nation looks to see if the Fed can slow wage growth and price inflation without disrupting it so much that unemployment jumps sharply and growth contracts.

“The amount of work the Fed has to do to make a soft landing is formidable,” said Megan Green, chief global economist at the Kroll Institute, a research arm of the Kroll consulting firm. “The trick is to cause a recession, and lean against inflation, without unemployment sustaining very high – it’s going to be difficult.”

Optimists, including many at the Fed, point out that this is an unusual economy. Job opportunities are plentiful, consumers have created savings buffers, and growth appears to be resilient, even if business conditions slow somewhat.

But many economists have said that when there is demand for labor and wages are rising, the Fed may need to take significant steam off the job market. Otherwise, companies will continue to raise labor costs with customers by raising prices, and families will retain their ability to spend thanks to rising salaries.

“They need to engineer some sort of growth slowdown — something that raises the unemployment rate to take pressure off the labor market,” said Donald Kohn, a former Fed vice president at the Brookings Institution. Doing so without outright slowdown is “a narrow road”.

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

But the Fed’s balance-sheet outlook has been more widely criticized policy, The Fed began buying massive amounts of government-backed debt at the start of the pandemic to calm bond markets. Once the terms were settled, it bought bonds at a pace of $120 billion, and continued to buy, while it became clear the economy was recovering faster than many expected and inflation was high.

Bond purchases in late 2021 and early 2022, which critics focus on, came partly because Mr. Powell and his colleagues did not initially think inflation would be long-lasting. He dubbed it “transient” and predicted it would fade on its own – in line with many private sector forecasts at the time.

When supply chain disruptions and labor shortages continued, leading to months of price hikes and wage increases, central bankers reevaluated. But even after they pivoted, it took time to ease bond purchases, and the Fed made its last purchase in March. Because the authorities preferred to stop buying bonds before raising rates, delaying the entire hardening process.

The central bank was trying to balance the risks: it did not want to quickly withdraw support from a remedial labor market in response to short-term inflation in early 2021, and then officials did not want to shake markets and a sharp reversal. Tax wanted to undermine his credibility. on their balance sheet policy. He sped up the process in an effort to be nimble.

“After all, there’s a really good chance that the Fed should have started tightening up earlier,” said Karen Dynan, a Harvard Kennedy School economist and former chief economist for the Treasury Department. “It was really hard to judge in real time.”

Nor was Fed policy the only thing that mattered for inflation. If the Fed begins to withdraw policy support last year, it may have slowed the housing market more quickly and set the stage for slower demand, but it won’t fix entangled supply chains. Or that doesn’t change the fact that many consumers have more cash on hand than usual after repeated government relief checks and spending months at home at the start of the pandemic.

“I think it will look something different,” Mr Cohn, who has been critical of the Fed’s sluggishness, said of the economy if it had reacted quickly. “Will it look much different? I don’t know.”

Still, a gradual move away from easy monetary policy may give inflation time to become a more permanent feature of American life. Once rapid price gains are embedded, they may prove difficult to eradicate, necessitating higher rates and possibly a more painful increase in unemployment.

For now, long-term consumer inflation expectations remain fairly stable, although short-term expectations have risen. The Fed is moving quickly to avoid a situation in which inflation replaces expectations and behavior more permanently.

James Bullard, chairman of the Federal Reserve Bank of St. Louis, has even suggested that officials may consider a rate hike of 0.75 points – though his colleagues showed little appetite for such a big move at the meeting. is indicated.

Michael Feroli, JPMorgan’s chief US economist, said in a research note that “it is very clear that this economy does not need stimulating monetary policy,” adding that he did not expect the Fed to raise interest rates so much, especially because it Had a tendency to broadcast his moves ahead of time.

“But if there is a time to break out of the habit, it is when the Fed’s inflation credibility is being questioned, and so we don’t write off the prospect of a big rate change,” he said.

What happens next with inflation and the economy will depend partly on factors beyond the control of the central bank: if the supply chain recovers and factories take hold, rising prices of cars, appliances, sofas and clothing will automatically lower them. There may be, and the Fed’s policies do little to slow demand.

Many economists expect inflation to peak in the coming months, although it is unclear how long it will take to fall below March’s 6.6 percent, somewhat in line with the 2 percent annual rate and the Fed’s average target over time. – Or is it possible without the pain and recession in the job market.

Former Fed Chair, Treasury Secretary Janet L. Yellen summed up the situation this way last month: “It’s not an impossible combination. But it will also require skill and good luck.,

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