Why the Fed risks a recession

Fears of recession are growing as the Federal Reserve launches an aggressive campaign to raise interest rates, and politicians and members of the public are increasingly questioning why central bankers plan to cause the economy pain.

The short answer is: This is the tool the Fed has to bring inflation under control.

The central bank is trying to force price increases to slow down. It does this by raising interest rates, making mortgages, car loans and corporate loans more expensive. As money becomes more expensive, it weighs on spending and renting, weakening the labor market and the broader economy – perhaps most notably. Slower growth will give supply an opportunity to meet demand.

The adjustment process is already an uncomfortable one: stock prices have fallen, home sales are starting to slow down and unemployment is likely to rise. But the Fed has one way of beating inflation, and that is by hammering out 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 famously a blunt tool,” Fed Chairman Jerome H. Powell said during testimony before senators on Wednesday. “There is a risk that weaker outcomes 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 with higher ratcheting, and anchoring – would be the bigger problem.

“This is very high inflation, and it hurts everyone,” he said. said Powell.

Fed officials have argued that they can slow down the economy enough to curb inflation without polluting demand so much that it plunges America into recession. Central bankers predicted last week that they would push up unemployment this year and next year, but not sharply.

But that soft landing is far from certain. While 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 production and restraining shipping standards – it has meant that the central bank may have to slow down demand even more. comply with a limited range of goods and services.

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

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