The fight against inflation can cause a recession, Fed Chairman Powell believes – Press Telegram

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CHRISTOPHER RUGABER | Associated Press

WASHINGTON — The Federal Reserve on Wednesday made its most direct calculations yet of what it will take to finally rein in painfully high inflation: slower growth, higher unemployment and a potential recession.

Speaking at a press conference, Chairman Jerome Powell acknowledged what many economists have been saying for months: that the Fed’s goal is to create a “soft landing” in which it manages to slow growth enough to contain inflation but not enough to cause recession – looks increasingly unlikely.

“The chances of a soft landing,” Powell said, “are likely to diminish” as the Fed steadily increases borrowing costs to slow the worst run of inflation in four decades. “Nobody knows if this process will lead to a recession, and if so, how big that recession will be.”

Before Fed policymakers consider ending rate hikes, he said, they need to see continued slow growth, a “modest” increase in unemployment and “clear evidence” that inflation is returning to its 2% target.

“We have to get rid of inflation,” Powell said. “I wish there was a painless way to do it. No.”

Powell’s remarks followed another significant rate hike of three-quarters of a point – for the third time in a row – by the Fed’s Policy Development Committee. His latest action raised the Fed’s key short-term rate, which affects many consumer and business loans, to 3% to 3.25%. This is the highest level since the beginning of 2008.

Falling gas prices have slightly dampened overall inflation, which was still a painful 8.3% in August compared to a year earlier. Lower gas prices may have contributed to a recent boost in President Joe Biden’s approval ratings, which Democrats hope will boost their prospects in November’s midterm elections.

On Wednesday, Fed officials also predicted that even more rate hikes were in the offing, raising their benchmark rate to around 4.4% by the end of the year – a full point higher than they expected back in June. And next year they expect to raise the rate to approximately 4.6%. This would be the highest level since 2007.

By raising borrowing rates, the Fed makes it more expensive to get a mortgage, car loan, or business loan. Consumers and businesses then presumably borrow and spend less, cooling the economy and slowing inflation.

Other major central banks are also taking aggressive steps to combat global inflation, which has been fueled by the recovery of the global economy after the COVID-19 pandemic and then by Russia’s war against Ukraine. On Thursday, the Bank of Great Britain raised the key interest rate by half a percentage point — to the highest level in 14 years. It was the Bank of England’s seventh consecutive move to increase borrowing costs at a time when rising food and energy prices have fueled a severe cost-of-living crisis.

Sweden’s central bank raised its key interest rate by a whole point this month. And the European Central Bank has secured its biggest-ever rate hike of three-quarters of a point for the 19 countries that use the euro.

In their quarterly economic outlook on Wednesday, Fed officials also predicted that economic growth would remain weak over the next few years and that the unemployment rate would rise to 4.4% by the end of 2023 from the current level of 3.7%. Historically, according to economists, whenever the unemployment rate rose by half a point in a few months, a recession always followed.

“So the (Fed’s) forecast is an implicit admission that a recession is likely unless something extraordinary happens,” said Roberto Perli, an economist at investment bank Piper Sandler.

Fed officials now forecast the economy will grow by just 0.2% this year, down significantly from their forecast of 1.7% growth just three months ago. And they project slow growth below 2% from 2023 to 2025. Even with the sharp rate hike the Fed envisions, it still expects core inflation — excluding volatile food and gas costs — to be 3.1% at the end of 2023, well above its 2% target.

In a speech last month, Powell warned that the Fed’s moves would “pain” households and businesses. And he added that the central bank’s commitment to reduce inflation to the 2% target was “unconditional”.

Short-term rates at the level the Fed is now targeting will force many Americans to pay much higher interest payments on a variety of loans than in the recent past. Last week, the average fixed mortgage rate topped 6%, a 14-year high, which helps explain why housing sales fell. Credit card rates hit their highest level since 1996, according to Bankrate.com.

Inflation now appears to be driven more by rising wages and sustained consumer spending, and less by the supply shortages that plagued the economy during the pandemic recession. On Sunday, Biden told CBS’ “60 Minutes” that he believes a soft landing for the economy is still possible, suggesting that his administration’s recent energy and health care legislation will lower pharmaceutical and health care prices.

The law may help lower prescription drug prices, but outside analyzes show it will do little to immediately reduce overall inflation. Last month, the nonpartisan Congressional Budget Office estimated that it would have a “negligible” effect on prices through 2023. Penn Wharton’s Budget Model of the University of Pennsylvania went even further, saying that “the impact on inflation is statistically indistinguishable from zero” over the next decade.

Even so, some economists are beginning to worry that the Fed’s rapid rate hike — the fastest since the early 1980s — will do more economic damage than is necessary to tame inflation. Mike Konchal, an economist at the Roosevelt Institute, noted that the economy is already slowing and that wage growth — a key driver of inflation — is leveling off and, by some measures, even declining slightly.

Polls also show that Americans expect inflation to ease significantly over the next five years. This is an important trend because inflationary expectations can become self-fulfilling: if people expect inflation to ease, some will feel less pressure to speed up their purchases. In that case, lower costs will help keep prices from rising.

The Fed’s rapid rate hike mirrors steps taken by other major central banks, fueling fears of a potential global recession. The European Central Bank last week raised the base rate by three quarters of a percentage point. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have raised rates significantly in recent weeks.

And in China, the world’s second-largest economy, growth is already suffering from repeated government COVID lockdowns. If a recession hits most major economies, it could derail the US economy as well.

AP Economics writer Paul Wiseman contributed to this report.

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