Federal Reserve Chairman Jerome Powell is facing an increasingly bleak reckoning after another hot inflation reading last week: He probably has to push the economy into recession to regain control of prices.
After spending much of the past year sounding a bit like inflation-tolerant former central bank chief Arthur Burns, Powell has increasingly taken on the mantle of inflation killer — and Fed icon — Paul Volcker. It’s a role he’ll probably gladly take on on Wednesday, when he speaks to reporters following the Fed’s widely anticipated decision to raise interest rates another half percentage point.
But, at least so far, he has avoided endorsing the harsh monetary medicine — and deep recession — that Volcker needed to stamp out inflation four decades ago. Although Powell has recently acknowledged that reining in price pressures might take some pain –and perhaps even higher unemployment – has steered clear of talk of a recession.
This is perhaps understandable, given how tense it is politically, especially for President Joe Biden’s Democratic Party ahead of the midterm elections in November.
“The Fed chairman doesn’t want the ‘r’ word to come out of his mouth in a positive way, that we need a recession,” said former US central bank policy maker Alan Blinder. “But there are a lot of euphemisms and he will use them.”
A growing number of economists – including former Fed Vice Chairman Blinder – say an economic contraction and rising unemployment may be needed to bring inflation down to more tolerable levels, let alone reach the target again. Fed’s 2% price target.
“I have become more pessimistic about the possibility of stabilizing inflation at an acceptable level without a recession,” said JPMorgan Chase & Co. chief economist Bruce Kasman. He sees a dynamic developing in which a prolonged period of high inflation and a tight labor market leads to high wage demands and higher costs for companies.
In a study published June 6, Bloomberg Economics’ chief US economist Anna Wong and her colleagues put the odds of a recession this year at one in four and one next year. next year in three out of four. “A recession in 2022 is unlikely, but a recession in 2023 will be hard to avoid,” they wrote.
Investors have taken note. Bond yields soared and stock prices fell on Friday on concerns the Federal Reserve will hit the brakes harder.or of the monetary policy after learning that consumer prices increased in May to a new maximum of 40 years, 8.6%, compared to the previous year. Investors tightened bets that the Federal Reserve would continue to raise interest rates in half-point steps at its July and September meetings, with some economists arguing that a larger hike of 75 basis points is now on the table.
The path and ultimate fate of interest rates in the coming months will depend in part on how quickly – and to what extent – policymakers want to cool inflation and how much pain they are willing to put the economy through to do so.
The price index of personal consumption expenditures – the Fed’s preferred gauge of inflation – it rose 6.3% in April from a year earlier, more than triple the central bank’s 2% target. Excluding volatile food and energy costs, core prices rose 4.9%.
Ethan Harris, head of global economics research at Bank of America Corp., said the Fed would probably be willing to compromise and accept a stagnation of inflation at 3%, with the idea of gradually tackling overshooting with the weather. That would allow him to avoid pushing the US into a recession.
“Let’s remember that the great fighter against inflation, Paul Volcker, backpedaled on 4% inflation,” Harris said.
The former chief economist of the International Monetary Fund, Olivier Blanchard, lamented the “blunder” of the Federal Reserve and other central banks by allowing inflation to run amok.
Blanchard, now a fellow at the Peterson Institute for International Economics, said central banks should stop tightening when inflation falls to 3% and set that price target, rather than risk a recession by lowering it to 2%.
Blinder said the Federal Reserve has to balance two competing risks.
The longer inflation remains high, the greater the chance that it will take hold in the economy. That’s what happened in the 1970s, when Burns was Fed chairman, and it’s the main reason why Volcker later had to put so much effort into the economy to reduce inflation.
But overly aggressive action to deal with persistent price pressures also carries dangers, the Princeton University professor said. It could push the economy into a very severe recession that triggers unemployment.
A Burns “Mistake”
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” if the Fed strayed from its 2% price target. And that’s a mistake he says Powell doesn’t want to make.
For now at least, Powell has something Burns didn’t: the political support to take action to combat inflation.
Biden, who had a rare meeting with Powell last month, has repeatedly reaffirmed the Fed’s independence to do what it deems necessary to deal with the rising prices. And the president has also made it clear that he considers high inflation to be the No. 1 economic problem facing the United States.
“Inflation is the bane of our existence,” Biden told ABC television host Jimmy Kimmel in an interview on June 8.