central bank faces inflation, but recession threatens

The US central bank (Fed) has promised to fight the highest inflation of the last 40 years, but that poses another threat to the world’s largest economy: that of a recession.

The institute will attempt a “soft landing,” assured its president, Jerome Powell.

In other words, to ease the pressure on prices, despite persistent global supply difficulties and the war in Ukraine that has pushed up the prices of gasoline and wheat, preserving economic growth.

A task that will require “millimeter calibration,” sums up David Wessel, longtime Fed observer for the Brookings Institution.

The U.S. economy has recovered from the Covid-19 pandemic and shows solid growth and record job gains, buoyed by generous government aid and action from the Fed, which lowered its key rates to zero in March 2020 , in order to support consumption.

But the American recovery has encountered various difficulties, including new waves of viruses and a shortage of goods and workers, which are driving up prices, and, now, the war in Ukraine.

To slow the consumption and investment frenzy of American consumers and businesses, the mighty Federal Reserve began raising policy rates in March, leading commercial banks to also raise the cost of borrowing to their customers.

– “Compromise” –

This first increase, of a quarter of a percentage point (0.25%), will be followed by many others. And several Fed officials, including its chairman, have warned they could be more aggressive in the coming months and raise rates by half a point directly, one or more times.

Global equity markets have collapsed in recent days as Lael Brainard, the only Democratic governor known for his dovish stances on monetary policy, also said it was “critical” to slow down inflation.

These strong positions show that Fed officials are “more likely to do too much than too little,” notes David Wessel.

Because the Fed, like many other economists, was caught off guard by the speed at which inflation shot up late last year, driven mostly by cars and homes.

In February it reached its highest level since 1982, at 6.4% over one year according to the PCE index, favored by the Fed, and at 7.9% according to another index, the CPI, on which it is falling back.

But the central bank has more than one trick up its sleeve and will also reduce the size of its balance sheet. That is to say, stop injecting millions of dollars into the economy and allow Treasury bills and other goods purchased since the start of the pandemic to sustain the good’s maturity without renewing the functioning of the markets.

It should start this process at its next meeting in May and move much faster than it did after the 2008 financial crisis.

– “Very different” situation from the 1970s –

The question, however, is what effect this action will have, along with rate hikes, which have never occurred before.

“It’s difficult,” commented David Wessel, who nevertheless notes that, given the strength of the economy, “a mild and brief recession (…) could be a trade-off that politicians are ready to make” to beat the inflation.

This situation obviously recalls the specter of the 1970s, when an inflationary spiral and the oil crisis pushed the central bank to drastically raise interest rates to cause a recession and lower prices.

But the current situation is “very different,” said Dana Peterson, chief economist on the Conference Board, who points in particular to a strong economy and labor market, and points out that the Fed has strengthened its credibility in the fight against ‘inflation.

Fed officials are looking into all the factors “and really want to calibrate them” to achieve a soft landing, and the Fed “will do everything in its power not to ‘go too far,'” he said. – she explained to the AFP.

However, the economist agreed, the central bank, even with the best will in the world, cannot control the obstacles that have led to these supply difficulties and, in particular, the sweeping pandemic.

hs / jul / vmt / spi

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