Fed chief sees narrower path to avoid a recession in inflation fight

The Washington Post / Rachel Siegel

11:49 JST, November 3, 2022

After months of fighting inflation, it’s “harder to see the path” for the Federal Reserve to control price increases without causing a recession – but officials believe letting inflation stay high would be worse than an economic downturn, Chair Jerome Powell said Wednesday, as the central bank raised its baseline rate by 0.75 percentage points for the fourth time this year.

Now the Fed shows no signs of backing down, even as Powell acknowledged that officials are making decisions without full certainty of how they will unfold.

“We’ve always said it was going to be difficult” to achieve a so-called “soft landing” without a recession, Powell said at a news conference after two days of meetings by the Fed’s open markets committee. “I think to the extent rates have to go higher and stay higher for longer, it becomes harder to see the path. It’s narrowed. I would say the path has narrowed over the course of the last year.”

Major U.S. stock markets – which have already been volatile over the prospect of rates that stay higher for longer – swerved off the news, with the Dow Jones industrial average briefly climbing more than 300 points before reversing course and turning negative. The Dow ultimately closed down 505 points, or 1.55 percent. The S&P 500 dropped 2.5 percent, and the Nasdaq dropped 3.36 percent.

The Fed effectively has only one tool to get inflation under control: the federal funds rate, or what banks charge each other to lend. That interest rate is blunt but wide-ranging, and it targets demand by influencing all kinds of borrowing, from mortgage rates and car loans to debt taken on by businesses. The Fed has now raised rates six times since March, pushing its policy rate between 3.75 and 4 percent, considered “restrictive” territory that should slow economic growth.

The Fed’s resolve to keep rates higher for longer comes as it falls under growing criticism from economists and Democrats on Capitol Hill that it is moving far too forcefully and not allowing enough time for its policies to take hold in the economy. Powell made clear that he doesn’t “have any sense we’ve overtightened,” and said “it is very premature to be thinking about pausing.”

“We have a ways to go,” he said.

A major reason the Fed has been piling on such whopping hikes is because it arrived late to the inflation fight. Central bankers initially said rising consumer prices would be temporary, as the economy regained its footing from the covid crisis. That read of the situation was wrong, and it put the Fed in a position of needing to work harder to cement its credibility and convince markets, elected officials and American consumers that it will do its job, even in a time of extreme uncertainty.

“A lot of this is obviously about narrative and communication. Whether or not they pause in the beginning of next year, or at the end of the first quarter – there aren’t huge economic effects,” said Wendy Edelberg, director of the Hamilton Project, a center-left think tank, and former chief economist at the Congressional Budget Office. “But they do matter in terms of credibility. Them pausing before they have a change in inflation to hang their hats on – it’s a problem. And I’m betting that they won’t pause until they see that.”

Even so, markets, Fed watchers and households and businesses nationwide are closely watching for any hints as to when and how officials will decide to ease up. The Fed’s own projections show a possible hike of half a percentage point at the next meeting in December, followed by a smaller hike in early 2023.

Powell seemed to creak open the door to a slowdown at upcoming meetings, but gave no precise guidance. He noted that the housing market, which is extremely sensitive to interest rate hikes, has cooled substantially as mortgage rates have soared. And the Fed’s policies have triggered tighter conditions throughout the financial system. But officials have yet to see anywhere near enough progress beyond that.

Prices in September rose 8.2 percent compared with the year before, and 0.4 percent compared with August, more than analysts’ expectations. Core inflation, a measure closely watched by the Fed that strips out more volatile categories such as food and energy, also came in hot. Powell said that since the last Fed policy meeting in September, data showing a still-hot labor market and a blistering inflation report suggests rates will have to move higher than officials expected just six weeks ago.

Through it all, the job market has remained remarkably resilient and is still churning. The unemployment rate is low, at 3.5 percent, and employers are still eager to hire workers, with the number of job openings rising in September to 10.7 million. Still, that’s the opposite of what Fed officials want to see, since they argue that the job market can soften without a sharp rise in unemployment if companies eliminate vacant jobs rather than laying people off.

But there will almost certainly be consequences from the most aggressive monetary policy in decades. The economy does not appear to be in a recession now, based on gross domestic product measurements, the labor market or consumer spending data. But the overarching fear is that the full force of the Fed’s moves will take months, if not a year, to sink in – and by then, it will be too late to head off a downturn. The Fed’s decisions are also being amplified as central banks around the world hike rates to tame inflation in their own countries, a precarious experiment that could soon send the global economy into a recession.

Fed officials take lag times into account. But Powell said the current high-inflation environment is too unfamiliar to be sure exactly how long it will take for higher rates to affect decisions by individual households and businesses.

There is also a challenge in weighing what’s happening in the economy now against what could happen in the future. But the Fed chief insisted that if it became clear that the central bank was overtightening, it could lower interest rates to add some juice to the economy. The bigger risk, he said, is not doing enough to zap inflation now.

“You want to consider them, but not take them literally,” Powell said of these lag effects and their influence over the economy. “So I think it’s a very difficult place to be. But I would want to be in the middle looking carefully at what’s actually happening with the economy.”

Outside the Fed, inflation has become a major issue for voters and candidates ahead of the midterm elections. Republicans have hammered Democrats for their sprawling stimulus measures earlier in the pandemic that helped supercharge demand and sent inflation on the upswing. Democrats, meanwhile, defend their policies as keeping the economy alive during the worst days of the health crisis.

The Fed closely guards its independence from politics and makes decisions regardless of which party holds Congress or the White House. But Democrats on Capitol Hill have recently ramped up their criticism of the central bank, arguing that such massive rate hikes will inevitably hurt the labor market. On Monday, 11 lawmakers, including Sens. Elizabeth Warren (D-Mass.) and Bernie Sanders (I-Vt.), issued a letter to Powell warning the Fed against inflicting needless harm.

“We are deeply concerned that your interest rate hikes risk slowing the economy to a crawl while failing to slow rising prices that continue to harm families,” the letter read.