Federal Reserve Chair Jerome Powell faces an increasingly grim calculus after another hot inflation read last week: He will likely have to push the economy into recession to get prices back under control.
After spending much of the past year sounding a bit like inflation-tolerant former Fed Chairman Arthur Burns, Mr. Powell has increasingly taken on the role of inflation-fighter and Fed icon Paul Volcker.
It’s a role he’s likely to happily accept on Wednesday, speaking to reporters following a widely anticipated Fed decision to raise rates by another half a percentage point.
But so far, at least, he has shied away from backing the harsh monetary medicine — and a punishingly deep recession — that it took Volcker to break the spine of inflation four decades ago.
While Mr Powell has recently acknowledged that it may take some pain and perhaps even higher unemployment to get price pressures under control, he has avoided talking about a recession.
That’s perhaps understandable given how tense this is politically, especially for President Joe Biden’s Democratic Party ahead of the November midterm elections.
“The Fed chairman doesn’t want to positively let the R-word slip that we need a recession,” said former Federal Reserve Board official Alan Blinder. “But there are many euphemisms and he will use them.”
A growing number of economists, including Mr Blinder, say it may take an economic slowdown and higher unemployment to bring inflation down to more tolerable levels, let alone return to the Fed’s 2% target.
“I’ve become more pessimistic about the possibility of inflation stabilizing at acceptable levels without a recession,” said Bruce Kasman, chief economist at JPMorgan Chase & Co.
He sees a dynamic development in which sustained high inflation and a tight labor market are leading to higher wage demands and additional costs for companies.
In a study published June 6, Anna Wong, chief US economist at Bloomberg Economics, and her colleagues put the chances of a recession at one in four this year and three in four next year.
“A 2022 downturn is unlikely, but a 2023 recession will be hard to avoid,” they wrote.
Investors are taking note.
Bond yields rose and stock prices fell on Friday on concerns that the Fed will tighten the policy brakes after it was revealed that consumer prices rose 8.6 percent year-on-year in May to a new 40-year high.
Investors were adamant that the Fed would continue to hike in half-point increments at its July and September meetings, with some economists arguing that a larger 75 basis-point hike is now on the table.
The trajectory and ultimate destination of interest rates over the coming months will depend in part on how quickly and how far policymakers want inflation to cool, and how much pain they are willing to inflict on the economy to achieve that.
The consumer spending index — the Fed’s preferred indicator of inflation — rose 6.3 percent year on year in April, more than triple the central bank’s 2 percent target. Excluding volatile food and energy costs, core prices rose 4.9 percent.
Ethan Harris, head of global economic research at Bank of America Corp., said the Fed would likely be willing to compromise and accept inflation plateauing at 3 percent, with the idea of gradually exceeding its target over time to tackle In doing so, it would avoid plunging the US into a downturn.
“Remember the great inflation fighter Paul Volcker backed down with inflation at 4 percent,” Mr Harris said.
Former International Monetary Fund chief economist Olivier Blanchard bemoaned the “failure” by the Fed and other central bankers to let inflation spiral out of control.
Mr Blanchard, now a senior fellow at the Peterson Institute for International Economics, said central banks should stop tightening policy when inflation falls to 3 per cent and set that as a new price target, rather than risk a recession by push them to 2 percent.
Mr Blinder said the Fed must weigh two competing risks.
The longer inflation stays elevated, the more likely it is to take root in the economy.
This is exactly what happened in the 1970s when Mr. Burns was Fed chairman, and is the main reason why Mr. Volcker subsequently had to guide the economy through such a dilemma in order to bring down inflation.
But there are dangers in overly aggressive measures to combat ongoing price pressures, the Princeton University professor said. It could plunge the economy into a very severe recession, causing unemployment to skyrocket.
Deutsche Bank economist Peter Hooper, who was one of the first on Wall Street to forecast a recession, said it would be a “Burnsian error” for the Fed to back away from its 2% target. And that’s a mistake Mr. Powell doesn’t want to make, he said.
For now, at least, Mr Powell has something Mr Burns did not: political support for anti-inflation measures.
President Biden, who held a rare meeting with Mr. Powell last month, has repeatedly reaffirmed the Fed’s independence to do what it sees necessary to manage rising prices.
And the President has also made it clear that he considers high inflation to be the number one economic problem in the United States.
https://www.independent.ie/business/world/us-fed-faces-choice-between-high-inflation-and-recession-41745329.html The US Federal Reserve faces a choice between high inflation and recession