The Fed aims to avoid a recession, but it is certainly possible

The Fed aims to avoid a recession, but it is certainly possible

US Federal Reserve Chair Jerome Powell sought on Wednesday to reassure the public that the Fed will raise interest rates high and fast enough to quell inflation, without tightening credit so much as to throttle the economy and cause a recession. Democrats wondered whether the Fed’s accelerated rate hikes will succeed in curbing inflation or might instead just tip the economy into a downturn.

Several Republicans charged that the Powell Fed had moved too slowly to begin raising rates and now must speed up its hikes.

Testifying to the Senate Banking Committee, Powell faced skeptical questions from members of both parties about the Fed’s ability to tame inflation, which has surged to the top of Americans’ concerns as congressional elections near.

Powell acknowledged that a recession is possible as the Fed pushes borrowing costs steadily higher.

Powell stressed that the Fed’s primary goal is to reduce inflation but said he still hopes to achieve a soft landing a reduction in inflation and a slowdown in growth without triggering a recession and high unemployment.

It’s certainly a possibility, he said in response to a question from Sen. John Tester, a Democrat from Montana. “It’s not our intended outcome, but it’s certainly a possibility.

We do think it’s absolutely essential that we restore price stability, really for the benefit of the labour market as much as anything else, Powell said on the first of two days of testimony as part of the Fed’s semiannual report to Congress.

He said the pace of future rate hikes will depend on whether and how quickly inflation starts to decline, something the Fed will assess on a meeting by meeting basis.

The central bank’s accelerating rate increases it started with a quarter-point hike in its key short-term rate in March, then a half-point increase in May, then three-quarters of a point last week has alarmed investors and led to sharp declines in the financial markets. Powell’s testimony comes exactly a week after the Fed announced its three-quarters-of-a-point increase, its biggest hike in nearly three decades, to a range of 1.5 per cent to 1.75 per cent.

With inflation at a 40-year high, the Fed’s policymakers also forecast a more accelerated pace of rate hikes this year and next than they had predicted three months ago, with its key rate reaching 3.8 per cent by the end of 2023. That would be its highest level in 15 years. Concerns are growing that the Fed will end up tightening credit so much as to cause a recession.

This week, Goldman Sachs estimated the likelihood of a recession at 30 per cent over the next year and at 48 per cent over the next two years. A senior Republican on the Banking Committee, Sen. Thom Tillis of North Carolina, on Wednesday accused Powell of having taken too long to raise rates, saying the Fed’s hikes are long overdue and that its benchmark short-term rate should go much higher.

Many economists agree that the additional spending contributed to rising prices by magnifying demand even while supply chains were snarled by COVID-related shutdowns and labour shortages were driving up wages. Inflation pressures were further worsened by Russia’s invasion of Ukraine.

Tillis, like many Republicans, also blamed President Joe Biden’s USD 1.9 trillion financial stimulus package, approved in March 2021, for being excessively large and exacerbating inflation. The Fed has largely boxed itself into a menu of purely reactive policy measures, Tillis said.

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