As the Federal Reserve on Wednesday prepares to raise interest rates, it faces the key issue of how to get inflation under control without causing a recession.
The market consensus calls for a half-percentage-point rate hike on Wednesday. Then the central bank is expected to continue increasing rates for the rest of this year and likely into next year as well.
Inflation is roaring, with the personal-consumption-expenditures price index, the Fed’s favored inflation indicator, rising 6.6% in the 12 months ended in March. That's the biggest increase in more than 40 years.
The Fed’s official inflation target is 2%, and interest rates will have to rise big-time to get it anywhere near that level, economists say.
Will There be a Soft Landing?
But the rate hikes, combined with the Fed’s expected reduction of its bulging balance sheet, could cause an economic downturn, experts say.
The central bank hopes to engineer a so-called soft landing for the economy, but that won’t be easy.
“They need to engineer some kind of growth recession — something that raises the unemployment rate to take the pressure off the labor market,” Donald Kohn, former Fed vice chairman and now senior fellow at the Brookings Institution, told The New York Times.
There is just “a narrow path” to accomplish that without sparking a recession, he said.
The unemployment rate totaled 3.6% in March. The number of jobs available hit a record that month, as did the number of times workers quit their jobs.
In some ways, the economy already looks fragile. Gross domestic product contracted an annualized 1.4% in the first quarter. But the drop came mainly from a slowdown in inventory growth and a widening trade deficit. Consumer spending and business investment -- the economy’s mainstays -- registered solid gains.
What Is Gross Domestic Product? TheStreet Explains.
"The economy is still showing some resilience, but the first-quarter GDP report signals the start of more moderate growth this year and next, largely in response to higher interest rates," Sal Guatieri, a senior economist at BMO Capital Markets, told Reuters. GDP soared 6.9% in the fourth quarter.
Larry Summers’s Doubts
Fed officials forecast that inflation will slide below 3% and unemployment will stay under 4% in 2023.
The Harvard economist and former Treasury Secretary Larry Summers is skeptical.
“Our recent research suggests that engineering a soft landing is highly improbable and that there is a significant likelihood of a recession in the not too distant future,” he and the Harvard research fellow Alex Domash wrote in The Conversation, an online journal.
While the Fed did achieve soft landings in 1965, 1984 and 1994, “these periods had little resemblance to the current moment,” the duo wrote.
“In all three episodes, the Fed was operating in an economy with significantly higher unemployment, lower inflation and lower wage growth.”
