America’s central bank, the Federal Reserve, is trying to strike a delicate balance: It has to take steps to slow down the economy to bring inflation under control — but it wants to do so without causing a severe recession.
The predicament is unusual for a government agency. Typically, public officials talk about stimulating the economy and creating more jobs.
The Fed is trying to do the opposite. Under its dual mandate from Congress, the Fed tries to keep unemployment low and prices relatively stable. Yet those two goals are sometimes in conflict: A strong economy can lead to more jobs but quickly rising prices, while a sluggish economy can lead to fewer jobs but slower price increases. The Fed aims to balance those extremes.
But as the Fed has moved to slow down the economy, some experts have worried that it’s going too far, risking unnecessary economic pain. The Fed’s defenders, meanwhile, say the central bank is acting wisely — and may even need to go further than it has to tame rising prices.
Today’s newsletter will explain both sides of the debate and the potential dangers to the economy if the Fed does too much or too little to bring down inflation.
The case for caution
Experts arguing for caution worry that the Fed has already done enough to ease inflation, even if the effects are not clear yet, and that any more action could backfire.
The Fed’s attempts to cool the labor market illustrate the potential risk.
The jobs market is one of the major drivers of inflation today, said Jason Furman, an economist at Harvard University. Many employers have raised wages to compete for hires; there are more job vacancies than there are available workers. But someone has to pay for the higher wages, and employers have passed those costs on to consumers by charging higher prices, fueling inflation.
In response, the Fed has raised interest rates five times this year to increase the cost of borrowing money. The goal: More expensive loans will result in less investment, then less business expansion, then fewer jobs, then lower pay, then less inflation.
There are hints that the Fed’s moves are working. For example, stock markets have declined as the Fed has raised interest rates — partly a signal that investors expect the economy to cool off, just as the Fed wants. “Markets going down is not an indictment of the Fed’s policy,” my colleague Jeanna Smialek, who covers the economy, told me. “Markets going down is the Fed’s policy.”
But the rest of the intended chain of reaction, from less investment to less inflation, will take time to work through the economy. The Fed’s interest rate hikes may have done enough, but the full effects aren’t visible yet.
Some experts worry the Fed will not wait long enough to see the full effects of its previous actions before it takes more aggressive steps. That could lead to more harm to the economy than necessary. “The risk that the Fed is moving too slowly to contain inflation has declined, while the risk that high interest rates will cause severe economic damage has gone up — a lot,” Paul Krugman, the economist and Times columnist, wrote last week.
The case for more
On the other side, there’s the risk of the Fed doing too little.
We have seen the consequences. The Fed, believing inflation would be temporary, was slow to raise interest rates last year. That probably exacerbated the rising prices we’re dealing with now.
But things could get worse. The longer inflation goes on, the likelier it is to become entrenched. For example, if businesses expect costs to keep rising, they will set prices higher in anticipation — leading to a vicious cycle of increasing costs and prices.
Longer bouts of inflation are also more likely to result in stagflation, when inflation is high and economic growth slows. In such a situation, people have a harder time finding a job and the pay they can get quickly loses value. The U.S. endured stagflation in the 1970s; Europe is facing it now as prices rise and the continent’s economy stumbles.
Entrenchment and stagflation could force the Fed to act even more drastically, with grave side effects. It has happened before: In the 1970s and ’80s, the Fed raised interest rates so dramatically and so quickly that the unemployment rate spiked to more than 10 percent.
By acting aggressively now, the Fed hopes to avoid such harsh measures — and produce a “soft landing” that reduces inflation without wrecking the economy.
The central bank’s record suggests it could pull off the feat, Alan Blinder, a former Fed vice chairman, argued in The Wall Street Journal: The Fed achieved a soft landing or came close in six of 11 attempts over the past six decades. “Landing the economy softly is a tall order, but success is not unthinkable,” Blinder wrote.
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