Powell’s stark message: Fighting inflation may cause an economic recession

The US Federal Reserve offered its harshest estimates on Wednesday about what it will finally take to tame painfully high inflation: slower growth, higher unemployment rates, and the potential for a recession.

Speaking at a news conference, President Jerome Powell acknowledged what many economists have been saying for months: that the Fed’s goal of engineering a “soft landing” – where it would be able to slow growth enough to curb inflation but not so much as to cause a recession – seemed unlikely. increasingly.

“The chances of a soft landing are likely to diminish,” Powell said as the Fed steadily raises borrowing costs to slow the worst inflation streak in four decades. “No one knows if this process will lead to a recession, or if so, how important that recession will be.”

Before Fed policymakers can even consider halting rate hikes, he said, they will have to see continued slow growth, a “modest” increase in unemployment and “clear evidence” that inflation is falling back to the 2% target.

“We have to put inflation behind us,” Powell said. “I wish there was a painless way to do it. There isn’t.”

Powell’s comments came on the heels of three more significant quarters of a point rate hike – the third in a row – by the Federal Reserve’s policy-making committee. His latest action has raised the Federal Reserve’s main short-term interest rate, which affects many consumer and business loans, to 3% to 3.25%. This is its highest level since early 2008.

Lower gas prices slightly lowered headline inflation, which was still a painful 8.3% in August compared to a year earlier. Those lower gas pump prices may have contributed to the recent spike in President Joe Biden’s public approval ratings, which Democrats hope will bolster their expectations in the November midterm elections.

On Wednesday, Fed officials also expected more large-scale increases, raising the benchmark interest rate to nearly 4.4% by the end of the year – a full point higher than they had anticipated as recently as June. They expect to raise the rate again next year to around 4.6%. This will be the highest level since 2007.

By raising borrowing rates, the Federal Reserve makes it more expensive to obtain a mortgage, car or business loan. Consumers and businesses are then supposed to borrow and spend less, cooling the economy and slowing inflation.

Other major central banks are also taking firm steps to combat global inflation, which is fueled by the global economic recovery from the COVID-19 pandemic and then Russia’s war against Ukraine. On Thursday, the British Central Bank raised its key interest rate by half a percentage point – to its highest level in 14 years. This was the seventh consecutive move by the Bank of England to increase borrowing costs at a time of rising food and energy prices, leading to a severe cost-of-living crisis.

This month, Sweden’s central bank raised its key interest rate by a full point. The European Central Bank achieved its largest increase ever, with an increase of three-quarters of a point in the 19 countries that use the euro currency.

In their quarterly economic outlook on Wednesday, Fed policymakers also expected economic growth to remain subdued over the next few years, with the unemployment rate rising to 4.4% by the end of 2023, up from its current level of 3.7%. Historically, economists say, any time unemployment has risen by half a point over several months, a recession has always followed.

“So the (Fed) forecast is a tacit acknowledgment that a recession is possible, unless something extraordinary happens,” said Roberto Burley, an economist at Piper Sandler, an investment bank.

Federal Reserve officials now expect the economy to expand by just 0.2% this year, sharply lower than their forecast of 1.7% growth just three months ago. And they expect growth to slow below 2% from 2023 through 2025. Even with the sharp rate hikes the Fed expects, it still expects core inflation — which excludes volatile food and gas costs — to be 3.1% at the end of 2023, which is higher Much more than average. 2% target.

Powell warned in a speech last month that the Fed’s moves would “bring some pain” to households and businesses. He added that the central bank’s commitment to reduce inflation to the 2% target was “unconditional”.

Short-term interest rates at the level the Fed now envisions will force many Americans to make much higher interest payments on a variety of loans than in the recent past. Last week, the average fixed-mortgage rate exceeded 6%, its highest level in 14 years, which helps explain why home sales have fallen. Credit card rates are at their highest level since 1996, according to Bankrate.com.

Inflation now appears to be increasingly fueled by rising wages and consumers’ constant desire to spend and to a lesser extent by the lack of supplies that crippled the economy during the pandemic recession. On Sunday, Biden said on CBS’ “60 Minutes” that he believes an easy landing for the economy is still possible, suggesting that his administration’s recent energy and health care legislation will lower drug and health care prices.

The law may help bring down prescription drug prices, but outside analyzes suggest it will do little to bring down headline inflation immediately. Last month, the nonpartisan Congressional Budget Office opined that it would have a “negligible” effect on prices through 2023. Ben Wharton’s budget model at the University of Pennsylvania went so far as to say that “the effect on inflation is statistically indistinguishable from zero” during the next decade.

However, some economists are beginning to express concern that rapid increases in federal interest rates – the fastest since the early 1980s – will do too much economic damage to tame inflation. Mike Konzal, an economist at the Roosevelt Institute, has noted that the economy is already slowing and that wage increases – the main driver of inflation – are stabilizing and some measures are falling.

Surveys also show that Americans expect inflation to drop dramatically over the next five years. This is an important trend because inflation expectations can be self-fulfilling: if people expect inflation to fall, some will feel less pressure to speed up their purchases. Less spending would help moderate price increases.

Rapid interest rate increases by the Federal Reserve mirror the steps other major central banks are taking, contributing to concerns about a possible global recession. Last week, the European Central Bank raised its benchmark interest rate by three-quarters of a percentage point. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have all raised interest rates significantly in recent weeks.

And in China, the world’s second-largest economy, growth is already suffering from repeated government shutdowns of the coronavirus. If a recession engulfs most of the big economies, it could derail the US economy as well.