US central bankers face an increasingly difficult balancing act as they struggle to calm scorching inflation while maintaining economic growth, despite having made it clear they are prepared to risk a recession.
But with war still raging in Ukraine and Covid-19 causing ongoing problems in Asia, avoiding an economic downturn will take luck and depend on many factors beyond the Federal Reserve’s control.
As families struggle to make ends meet as gas, food and home prices soar and more Americans take on second jobs to pay the bills, Fed officials have made it clear that fighting inflation is their top priority, even if it means causing them pain.
The Fed holds its two-day monetary policy meeting next week, at which it is expected to raise interest rates by another three-quarters of a percentage point on Wednesday in its aggressive campaign to cool demand and ease price pressures.
Despite a healthy job market with unemployment near record lows, workers’ wage increases are being overwhelmed by sky-high consumer prices, which rose to a new 40-year high of 9.1 percent in June.
The economic slowdown is likely to result in more job losses, but policymakers are keen to avoid the greater pain of a price spiral that entrenches or spirals out of control.
Treasury Secretary Janet Yellen, herself a former Fed chair, warned last week that achieving a “soft landing… will take skill and a lot of luck.”
– Aggressive rate hikes –
Former Fed Vice Chairman Donald Kohn agreed.
“It’s a very complicated, multi-dimensional problem,” Kohn told AFP, particularly given the ongoing uncertainty in the supply chain.
After the world’s largest economy was inundated with support during the pandemic — zero interest rates and a steady flow of liquidity into the financial system — Fed policymakers applauded how quickly the economy is recovering, regaining millions of jobs in a matter of months Has.
But they were caught off guard by the rapid rise in prices as Americans, awash with cash from massive government aid, went on a spending spree, buying up cars, homes and other goods as the global supply chain stalled due to pandemic lockdowns , which persist in China.
The Fed finally got going in March – taking interest rates from zero – and starting a hike of 25 basis points, followed by 50 in May and 75 in June.
Higher borrowing costs make it more expensive to borrow money to buy cars and homes or to expand businesses, which should dampen demand while making saving more attractive than spending.
Other major central banks have followed suit, including the European Central Bank, which took its first step last week.
Fed Chair Jerome Powell said last month that the policy-making Federal Open Market Committee would consider either a 50 or 75 basis-point hike at its July meeting, and most economists expect a repeat of June’s three-quarter-point hike.
Fed Governor Christopher Waller recently floated the idea of a gargantuan 100 basis point hike, which would be the first since the Federal Reserve began using the federal funds rate for monetary policy in the early 1990s.
The same level of tightening in a single move has not been seen since the early 1980s, when then-Fed Chair Paul Volcker was on a crusade to smash a wage-price inflation spiral.
– Mixed Dates –
But even Waller noted that it’s important not to act too quickly, and a full point raise would only be needed if the data continues to show accelerating price advances.
“I think they’re probably going to discuss 100 basis points just because the inflation picture is still very bad,” said Julie Smith, an economics professor at Lafayette College.
However, some recent data “suggest that previous rate hikes have very likely started to have an effect,” she said in an interview.
Home prices have skyrocketed, hitting repeated new records, even as interest rates have risen and consumer spending continues to rise, prompting some economists to warn of a second-quarter decline.
But there are signs of cracks, including falling home sales, a dramatic drop in mortgage applications and a rising share of spending on essentials.
Officials said the US economy was strong enough to withstand higher interest rates without a serious downturn, but others, including former Treasury Secretary Lawrence Summers, said they were overly optimistic and that job losses would need to rise sharply to tame inflation.
Kohn said it’s important that Powell communicates clearly what data the Fed is looking for to slow or halt the rate hike cycle.
“I think a fairly shallow recession” with unemployment higher than the 3.7 percent forecast by the Fed last month “will be necessary to break this spiral of inflation,” he said.
“But, boy, the uncertainty about that is just huge.”
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