Fed Chai Powell faces the choice between inflation and recession

FFederal Reserve Chairman Jerome Powell faces an increasingly grim reckoning after another hot inflation reading last week: He likely needs to push the economy into recession in order to regain control of inflation. price.

After spending much of the last year looking a bit like inflation-tolerant former central bank chief Arthur Burns, Powell has increasingly taken on the role of inflation killer and Fed icon Paul Volcker. It’s a role he’ll likely take on with relish on Wednesday, when he talks to reporters after a widely expected decision by the Fed to raise interest rates another half a percentage point.

But so far at least, he has been reluctant to endorse the harsh monetary medicine — and deep, punitive recession — that it took Volcker to break the back of inflation four decades ago. While Powell recently acknowledged that tackling price pressures could take some pain — and possibly even higher unemployment — he avoided talk of a recession.

That’s perhaps understandable, given the political heaviness, especially for President Joe Biden’s Democratic Party ahead of the midterm elections in November.

“The Fed chairman doesn’t want to let the ‘r’ word slip out of his mouth in a positive way, that we need a recession,” said former U.S. central bank policymaker 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 it may take economic contraction and rising unemployment to bring inflation back to more tolerable levels, let alone to the 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 lead to high wage demands and higher costs for businesses.

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

Investors take note. Bond yields jumped and stock prices fell on Friday on fears the Fed may be tightening policy brakes after consumer prices were reported to hit a new 40-year high of 8.6% in May compared to the previous year. Investors hardened bets that the Fed would continue to hike by half a point at its July and September meetings, with some economists arguing that a bigger 75 basis point hike was now on the cards. table.

The trajectory and eventual destination of interest rates in the months ahead will depend in part on how quickly and how much policymakers want inflation to slow and how much pain they are willing to inflict on the economy. economy to achieve this.

The personal consumption expenditure price index – the Fed’s preferred gauge of inflation – rose 6.3% in April from a year earlier, more than three times the 2% target of the central bank. Excluding volatile food and energy costs, underlying prices rose 4.9%.

Ethan Harris, head of global economic research at Bank of America Corp., said the Fed would likely be willing to compromise and accept a 3% cap on inflation, with the idea of ​​remedy gradually overshooting its target over time. This would allow him to avoid plunging the United States into a recession.

“Recall that great inflation fighter Paul Volcker pulled back with inflation at 4%,” Harris said.

Former International Monetary Fund chief economist Olivier Blanchard lamented the “failure” of the Fed and other central bankers in allowing inflation to spiral out of control.

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

Blinder said the Fed had to balance two competing risks.

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

But acting too aggressively to combat lingering price pressures also carries dangers, the Princeton University professor said. This could plunge the economy into a very severe recession that would cause unemployment to skyrocket.

“Burnsian’s Error”

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

At least for now, Powell has something Burns didn’t have: political support to take action to fight inflation.

Biden, who held a rare meeting with Powell last month, has repeatedly reaffirmed the independence of the Fed to do what it deems necessary to combat soaring prices. And the president has also made it clear that he views high inflation as the No. 1 economic problem facing the United States.

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

–With the help of Philip Aldrick.

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