Why the Fed Is Risking a Recession

Why the Fed Is Risking a Recession

Recession fears are rising as the Federal Reserve embarks on an aggressive campaign to raise interest rates, with politicians and members of the public increasingly wondering why central bankers plan to cause the economy pain.

The short answer is: this is the tool that the Fed has to control inflation.

The central bank is trying to force a slowdown in price increases. It does this by raising interest rates, which makes mortgages, car loans, and business loans more expensive. As money becomes more expensive, it weighs on spending and hiring, weakening the job market and the broader economy, perhaps notably. Slower growth will give supply a chance to catch up with demand.

The adjustment process is already nasty: Stock prices have fallen, home sales are beginning to slow, and unemployment is likely to rise. But the Fed has a way of bringing inflation back in line, and that is by pummeling households and businesses until they stop spending so much. Central bankers have recognized that the transition could be bumpy and that a recession is a real risk.

“Monetary policy is famous for being a blunt tool,” Fed Chairman Jerome H. Powell said during his testimony before senators on Wednesday. “There is a risk that weaker results are certainly possible, but that is not our intention.”

At the same time, they say that not trying to cool inflation, allowing it to continue to rise and entrench itself, would be the biggest problem.

“This is very high inflation and it’s hurting everyone,” Powell said.

Fed officials have argued they could slow the economy enough to allow inflation to moderate without stifling demand so much that it plunges the United States into a recession. Central bankers forecast last week that they will boost unemployment slightly, but not sharply, this year and next.

But that soft landing is far from safe. As shocks continue to rock the economy (the war in Ukraine has raised food and fuel costs, Chinese lockdowns to contain the pandemic have slowed factory output, and shipping grunts persist), it has meant that the central bank may have to cut demand further. to bring you online with a limited supply of goods and services.

“It is certainly a possibility; it’s not our intention at all,” Powell said of a recession. “Certainly the events of the last few months around the world have made it more difficult for us to achieve what we want, which is 2 percent inflation and still a strong job market.”

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