Fed Chai Powell faced with a choice between inflation and recession

fEderal Reserve chairman Jerome Powell faces an increasingly grim calculus after yet another hot inflation reading last week: He will likely need to push the economy into recession to get prices back under control.

After sounding like the inflation-tolerant, former head of the central bank Arthur Burns for much of last year, Powell has increasingly taken on the role of inflation killer – and Fed icon – Paul Volcker. It’s a role he’s likely to be happy to embrace on Wednesday, when he speaks to reporters following a widely anticipated decision by the Fed to raise interest rates by another half a percentage point.

But so far, he has balked at endorsing the hard money drug — and the punishingly deep recession — that Volcker needed to break inflation four decades ago. While Powell has recently acknowledged that it could hurt some to bring price pressures under control, and perhaps even more unemployment, he has avoided talking about a recession.

That’s perhaps understandable given how political that is, especially for President Joe Biden’s Democratic Party in the run-up to November’s midterm elections.

“The Fed chairman doesn’t want to let the word ‘r’ slip out of his mouth in a positive way that we need a recession,” said Alan Blinder, former Federal Reserve policymaker. “But there are many euphemisms and he will use them.”

A growing number of economists — including ex-Fed Vice Chairman Blinder — say an economic contraction and higher unemployment may be needed to bring inflation back to more acceptable levels, let alone back to the 2% price target. Fed.

“I’ve become more pessimistic about the possibility of stabilizing inflation at acceptable levels without a recession,” said Bruce Kasman, chief economist at JPMorgan Chase & Co. labor market leads to higher wage demands and more costs for companies.

In a study published on June 6, Anna Wong, chief economist at Bloomberg Economics, and her colleagues estimated the odds of a recession this year at one in four and at one in three in four for next year. “A downturn in 2022 is unlikely, but a recession in 2023 will be hard to avoid,” they wrote.

Investors pay attention. Bond yields skyrocketed on Friday and stock prices plunged on Friday amid concerns that the Fed will step on the policy brake following news that consumer prices rose 8.6% in May to a new 40-year high, compared to a year earlier. Investors hardened the bet that the Fed would continue to hike in half-point increments during its July and September meetings, with some economists arguing that a bigger 75 basis point hike was now on the table.

The path and ultimate destination of interest rates in 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 put the economy through to achieve it.

The consumer spending price index – the Fed’s favorite inflation gauge – rose 6.3% in April from a year earlier, more than three times the central bank’s target of 2%. 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 will likely be willing to compromise and accept a stabilization of inflation at 3%, with the idea of ​​gradually exceeding its target. to grab. That way it could prevent the US from falling into a downturn.

“Remember, the great inflation fighter Paul Volcker pulled out with an inflation rate of up to 4%,” Harris said.

Former chief economist of the International Monetary Fund, Olivier Blanchard, complained that the Fed and other central bankers were letting inflation spiral out of control.

Blanchard, now a senior fellow at the Peterson Institute for International Economics, said central banks should stop tightening policies when inflation falls to 3% and set that as the new price target, rather than risk a recession by to be reduced to 2%.

Blinder said the Fed has to balance two competing risks.

The longer inflation remains high, the more likely it is to become entrenched in the economy. That’s what happened in the 1970s, when Burns was Fed chairman, and it’s the main reason why Volcker then had to put the economy through such a wringer to bring inflation down.

But overly aggressive action to deal with ongoing price pressures also carries dangers, the Princeton University professor said. It could push the economy into a very severe recession, causing unemployment to skyrocket.

‘Burnsian Error’

Deutsche Bank economist Peter Hooper, who was one of the first on Wall Street to predict a recession, said it would be a “Burnsian mistake” if the Fed pulled back from its 2% price target. And that’s a mistake he said that Powell doesn’t want to make.

For now, Powell has something Burns didn’t have: political support for taking measures to fight inflation.

Biden, who had a rare meeting with Powell last month, has repeatedly reaffirmed the Fed’s independence to do whatever it deems necessary to deal with rising prices. And the president has also made it clear that he views high inflation as the number 1 economic problem facing the US.

“Inflation is the bane of our existence,” Biden told ABC TV host Jimmy Kimmel in a June 8 interview.

—With help from Philip Aldrick.

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