Fed’s inflation-fighting record marked by failures


Nine times since 1961, the central bank has embarked on a series of interest rate hikes to contain inflation. Eight times a recession followed. According to a March 25 report from investment bank Piper Sandler, the only real “soft landing” – as significant rate hikes without subsequent falls are called – occurred in 1994. It’s not a great track record.

Now, as the Fed begins another round of rate hikes to tackle the worst inflation in 40 years, the central bank is once again raising concerns that it is doing too little too late and may have to overcompensate. completely stifling economic growth.

These concerns are more pronounced than usual due to the extraordinary circumstances facing the United States: soaring prices fueled by pandemic-induced supply chain disruptions and a war with no end in sight that has rocked energy and commodity markets. New figures to be released by the government on Thursday should underline the persistence of price spikes.

“The Fed is well aware of the huge stakes here, but in some ways these are unknown circumstances,” said David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. “They are aware that they might have to be very aggressive with rate hikes and that could lead to a significant recession.”

Fed Chairman Jerome Powell is certainly aware of the criticism. He spoke about it directly last week when he laid out some of the central bank’s past victories – he cited 1965, 1984 and 1994 as years when the country escaped recessions after a series of rate hikes, in a speech that almost sounded like a Fed pep rally. .

A person close to the Fed acknowledged that the central bank – along with many other economists – had been taken by surprise by the economy’s continuing difficulties. Among the unexpected events: the inability of the labor force to return to pre-pandemic levels despite the explosion in the number of job creations and the severity of supply chain problems, which have fueled inflation . Hardly anyone foresaw the turmoil caused by Russia’s war against Ukraine.

The person said Powell did not intend to use the March 21 speech to the National Association for Business Economics as a show of overconfidence about the Fed’s ability to bring inflation down – which is rose to nearly 8% in February – with no collateral damage.

Rather, he sought to convey optimism that soft landings have been made in the past, they said. And the central bank isn’t that far off from what it sees as a normal interest rate target of around 2.4%, so it may not have to go too far too far. quickly in a way that could harm the economy.

Fed officials expect some easing of supply issues this year and more administrative action to resolve blockages, such as further easing safeguards at ports and making faster decisions on moving supplies. products and supplies to markets.

Yet the history of Fed rate hike cycles is littered with economic damage. An example was towards the end of the dotcom bubble in 2000, when the Fed failed to raise rates until it was too late and cheap money blew up dodgy online companies. like Pets.com shortly after traders celebrated “Dow 10,000”. with party hats on the floor of the New York Stock Exchange.

The Fed also pushed rates low during the ensuing recession, which was followed by a spike in house prices that lasted through 2006 before crashing – an event that crushed homeowners. , wiped out many banks and triggered the global financial crisis.

Two of the three soft landings Powell cited in his speech are questionable, according to Piper Sandler. In 1965, the Fed never raised rates above the neutral rate of inflation, meaning rates were low and stayed low for the most part.

In 1984, the Fed finally had to reverse the trend and cut rates significantly over the next two years. The central bank is credited by economists with a recent soft landing, the big hikes of 1994 that caused no recession and cemented the reputation of then-chairman Alan Greenspan of Washington’s Oracle.

Today, President Joe Biden and politicians from both parties have been mostly willing to give the Fed the benefit of the doubt, knowing that they have limited firepower to do much on their own except pray. .

Democrats are worried about growth-killing rate hikes amid a midterm election year. But inflation is even worse for them politically. Recent polls show that price spikes are by far the biggest concern of voters. An NPR/Ipsos survey showed that 40% of Americans are worried about rising prices and 94% are aware of rising costs for food, energy, housing and other items.

Republicans have either been silent on the issue now that rates are rising or are criticizing Powell for keeping them too low for too long. During a hearing on Capitol Hill earlier this month, Senator. Richard Shelby of Alabama, a senior Republican Banking Committee official, ostensibly asked Powell if he was “willing to do what it takes wholeheartedly to protect price stability.”

“Yes,” Powell replied.

“It would be a departure from what you did,” Shelby said.

Some conservatives are demanding more openness from the Fed and questioning the power its governing body, the Federal Open Market Committee, wields over the economy.

“The FOMC makes things up as they go,” said author and investment banker Chris Whalen. “Fed policy on COVID and the economy is largely speculative and ambitious.”

Whalen and other conservative economists frown on the way the central bank has used its authority since the financial crisis to buy trillions of dollars of government securities to pump money into the economy, a process known as of “quantitative easing”.

“Hope is the main input,” Whalen said. “Congress should demand a more detailed explanation of QE.”

The Fed has its critics on the other side of the argument, who say inflation is primarily caused by supply disruptions that the central bank can do next to nothing to help.

Still other economists do not believe the Fed is in serious danger of plunging the economy into recession. Ed Yardeni of Yardeni Research noted that the initial rate hike this month was only a quarter point and said much bigger and faster increases don’t seem likely.

“In the past, the Fed has realized [lower inflation] tightening until the resulting credit crunch causes a recession, which always lowers inflation,” he wrote. “The Fed shows no sign that it’s ready to do that anytime soon.”

For his part, Powell is trying to sell a message — a message that stock investors have been buying so far — that the Fed will be able to rein in inflation without hurting the economy.

In fact, the underlying economy – with solid demand, a slowing but still robust housing market and low unemployment – ​​is probably strong enough to sustain some rate hikes.

“No one expects a soft landing to be simple in today’s environment – very little is simple in today’s environment,” Powell said in his speech last week. “My colleagues and I will do our best to succeed in this difficult task.”

Victoria Guida contributed to this report.


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