With Europe at war and rising prices for a maximum of four decades, Fed Chairman Jerome Powell will strive for a “soft landing”: a gradual slowdown in economic activity that helps curb rising prices while the labor market and economy grow. .
However, many economists are concerned that with rising gas and commodity prices the additional burden of high interest rates could completely stifle growth.
“You have to be both lucky and good to not cause a downturn,” said Alan Blinder, an economist at Princeton University who served as deputy chairman of the Fed from 1994 to 1996, when the central bank was considered a soft landing.
As a first step, the Fed is set to raise lending rates several times this year, starting this week with a quarter-point increase in its benchmark short-term rate. Politicians will also discuss when and how to quickly cut Fed bonds by $ 9 trillion, which will also boost credit for consumers and businesses.
Such steps mean a sharp turn from the Fed’s ultra-low interest rate policy, which it adopted when a pandemic recession erupted two years ago. By pegging its key rate around zero for two years and buying trillions of bonds, the Fed kept the cost of loans at historically low levels and helped raise stock prices.
The Fed, by its own admission, underestimated the breadth and persistence of high inflation since the start of the pandemic. Many economists say the central bank has made its task more risky, waiting too long to start raising rates.
The average 30-year fixed rate on mortgages, which reached a record low of 2.65% in January 2021, jumped to 3.85% in the last three months as Powell signaled the Fed’s intentions and inflation rose.
By raising short-term rates, the Fed hopes to make buying homes and cars more expensive and raise credit card rates and borrowing costs for businesses. As a result, spending rollbacks should, in turn, slow inflation, Powell said in Congress two weeks ago. Strong consumer spending, backed by stimulus checks and steady increases in hiring and wages, faced supply shortages, which raised inflation to 7.9%, the highest level since 1982.
“People will spend less, and we hope to reach a level where supply and demand are in sync,” Powell said at a Senate banking committee hearing.
If the Fed succeeds, he said, the economy should continue to grow and unemployment will remain low over time – now at 3.8% – or decline further.
“I think we are more likely to be able to achieve what we call a soft landing,” Powell said at a House of Representatives meeting the day before his Senate testimony.
However, the Fed is facing a dizzying set of uncertainties that will make its task particularly challenging. The economy is still running through a shortage of labor and parts as a result of pandemic disruptions. And now prices for oil, gas, wheat and other goods are rising even more because of Russia’s war against Ukraine.
The clearest soft landing was achieved in 1994 and 1995, when the Fed, led by Chairman Alan Greenspan, raised the target from 3% to 6% when the economy recovered from a brief recession. Inflation, which was not a problem at the time, continued to decline. And unemployment leveled off at about 5.5% before resuming its decline in two years.
Blinder estimated that the Fed also developed a soft landing in 1965 and 1983. But he worries that this time the chances coincide with the Fed and that raising its rates could lead to an economic downturn.
“It’s so hard in these conditions,” he said. “You have to have a world where nothing can overturn a cart of apples. And for Jay Powell and the Fed, the whole world is just an apple cart behind an apple cart that gets lost.”
One such apple is the sharp rise in gas prices after the invasion, the national average of 65 cents to $ 4.33 a gallon. The increase will lead to rising inflation, and is likely to slow growth – two conflicting trends that are difficult for the Fed to manage simultaneously.
Last week, Goldman Sachs cut its growth forecast for this year to 2.9% from a previous estimate of 3.1%. Others predict a slowdown to 2% from 5.7% last year.
The constant development of the economy does provide some cushion against higher tariffs and more expensive gas. Consumers are spending at a healthy pace, and employers continue to hire quickly. There are another 11.3 million vacancies, far exceeding the number of unemployed.
In 1998, the late Massachusetts Institute of Technology economist Rudiger Dornbusch wrote that economic growth did not die from “natural causes.” Rather, he said, “they were all killed by the Fed because of the inflation problem.” He meant that the Fed had raised rates too much for fear of inflation and failed to achieve a soft landing.
However, many economists say the view is outdated and applies largely to Fed policy from the 1950s to the early 1980s. Now the Fed is acting differently. She communicates her plans to the public more clearly. At the same time, more attention is being paid to factors such as inflation expectations, which measure where consumers, businesses and investors see inflation.
Such measures are important because if people think inflation will be higher, they will demand higher wages. Companies, in turn, will raise prices further to offset higher labor costs.
Inflation expectations, especially in the short term, are rising steadily, although longer-term measures suggest that people still expect inflation to return closer to the Fed’s 2% annual target.
Amy Nakamura, a professor of economics at the University of California, Berkeley, noted that in the 1970s, even though inflation rose sharply, economists were still debating whether Fed policy could really control inflation.
However, if the Fed continues to raise rates for another year or two, as many economists expect, it could eventually raise them high enough for consumers and businesses to cut costs and throw the economy in reverse. Unemployment will rise and a recession may begin.
Stephen Stanley, an economist with Amherst Pierpont, has suggested that the Fed will not reach this opportunity until next year or later.
“Let’s raise the stakes at least a little bit before we start worrying about it,” he said. “We need to go some distance before it becomes a real concern.”
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