America’s central bank, the Federal Reserve, is trying to strike a delicate balance: It has to take steps to slow the economy to keep inflation under control — but it wants to do so. does not cause a serious recession.
The predicament is unusual for a government agency. Usually, public officials talk about stimulating the economy and creating more jobs.
The Fed is trying to do the opposite. Under the dual mandate of Congress, the Fed tries to keep unemployment low and prices relatively stable. However, those two goals sometimes contradict each other: A strong economy can create more jobs but prices rise rapidly, while a sluggish economy can lead to fewer jobs but prices rise more slowly. The Fed aims to balance those extremes.
But as the Fed has moved to slow the economy, some experts have worried that it will go too far, putting the economy at risk unnecessarily. Meanwhile, Fed defenders say the central bank is acting wisely — and may even need to go further to tame rising prices.
Today’s report will explain both sides of the debate and the potential risks to the economy if the Fed does too much or too little to bring down inflation.
Cases that need caution
Prudence experts argue that the Fed has done enough to reduce inflation, even if the effects are not yet clear and any further action could backfire.
The Fed’s efforts to cool down the labor market show the potential danger.
Jason Furman, an economist at Harvard University, says the job market is one of the main drivers of inflation today. Many employers have raised wages to scramble for hires; there are more vacancies than the number of existing workers. But someone had to pay higher wages, and employers passed those costs on to consumers by charging higher prices, fueling inflation.
In response, the Fed raised interest rates five times this year to increase borrowing costs. The goal: More expensive loans will lead to less investment, then less business expansion, then fewer jobs, then lower wages, then less inflation.
There are signs that the Fed’s moves are working. For example, the stock market fell when the Fed raised interest rates – in part a signal that investors expected the economy to cool, just as the Fed wanted. “A bear market is not an indictment of Fed policy,” my colleague Jeanna Smialek, who is in charge of the economy, tells me. “The bear market is Fed policy.”
But the rest of the expected chain of reactions, from less investment to less inflation, will take time to hit the economy. The Fed’s rate hike may have been enough, but the full impact is yet to be seen.
Some experts worry the Fed won’t wait long enough to see the full impact of its previous actions before taking stronger steps. That could lead to more damage to the economy than necessary. Paul Krugman, economist and Times columnist, said: “The risk that the Fed is moving too slowly to contain inflation has receded, while the risk that high interest rates will cause severe economic damage has increased – a lot”. Written last week.
Where to know more
On the other hand, there is a risk that the Fed does too little.
We have seen the consequences. The Fed, believing that inflation will be temporary, was slow to raise interest rates last year. That could exacerbate the rising prices we’re dealing with.
But things could get worse. The longer inflation persists, the more likely it is to become entrenched. For example, if businesses expect costs to continue to rise, they will set prices higher in anticipation – leading to a vicious cycle of increasing costs and prices.
Prolonged inflation is also more likely to lead to stagnant inflation, when inflation is high and economic growth slows. In such a situation, people have a harder time finding work and the salary they could get would quickly lose value. The United States suffered from stagnant inflation in the 1970s; Europe is currently facing this situation as prices rise and the continent’s economy struggles.
Recession and stagnant inflation could force the Fed to act even more aggressively, with serious side effects. It’s happened before: In the 1970s and ’80s, the Fed raised interest rates so rapidly and so rapidly that the unemployment rate skyrocketed to more than 10%.
By acting aggressively now, the Fed hopes to avoid such harsh measures — and create a “soft landing” that will lower inflation without weakening the economy.
Central bank records show it can hit the mark, said Alan Blinder, former Fed vice president, Debate in The Wall Street Journal: The Fed has achieved a soft landing or finish in six of its 11 attempts over the past six decades. “Landing the economy lightly is a tall order, but success is not utopian,” writes Blinder.
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