Several Fed officials have made it clear that they are willing to risk a recession while avoiding a worse consumer mentality: expectations of high and persistent inflation.
At a forum in Portugal last week, Fed Chairman Powell said frankly that the goal of a “soft landing” for the economy may not be achieved, that is, to suppress inflation without causing a recession, “Of course a recession is a risk, but I don’t think it is the biggest risk. “The biggest mistake will be failing to restore price stability.”
Nick Timiraos of the Wall Street Journal (WSJ), recognized by the market as the Fed’s microphone, reported that the remarks showed that the Fed is worried that once households and businesses believe that high inflation will continue, it may lead to expectations, so they prefer to actively raise interest rates to break the trend. kind of mentality.
Rising inflation occurs when goods and services are in short supply, and central bankers believe consumer expectations will have a powerful influence on inflation when unemployment falls at a natural, balanced level. It’s a self-fulfilling phenomenon: when consumers expect prices to rise again within a year, they buy now first.
Concern over rising inflation expectations was one factor that prompted the Fed to raise interest rates three yards in June and forecast a similar rate hike in July. The Fed will hold a decision-making meeting on the 26th and 27th of this month.
The reasons for the anxiety of Fed officials can be summarized as follows. First, the literature shows that if inflation is low, people don’t pay much attention to price changes, but if it rises to a level, it will start to affect people’s long-term expectations.
Second, some Fed economists have recently pointed to a gap in experts’ understanding of changes in inflation expectations.
Third, since the outbreak of the epidemic, the economy has suffered a series of blows, which has drawn more attention to inflation. From the outbreak of the epidemic, the damage to supply chains and employment relationships; then large-scale stimulus brought huge demand, hit the stage of economic restart, leading to deepening bottlenecks; then this spring’s war in Ukraine, energy, food, commodity prices soaring.
Economists have several indicators that track inflation expectations, including consumer surveys, bond market tools and economic models. Most of these indicators show that inflation expectations, although rising, are still in the range of recent history.
But central bankers have vivid memories of the inflation nightmare of the 1970s, and longtime Fed economist John Roberts said: “Insufficient tightening has more serious consequences, and the central bank is in full-scale inflation war mode by Yes, but it also represents a heightened risk of recession.”
John Cochrane, a senior researcher at the Hoover Institution, analyzed that if long-term inflation expectations for households do not rise and there is no new economic shock, the Fed will raise its benchmark interest rate to 3-4% next year, which may lead to inflation in the next few years. Swelled back down to 2%. But if inflation expectations continue to rise, the Fed will have to raise its benchmark rate to 9% to achieve the same effect.
Former New York Fed President William Dudley believes that Powell has no choice but to declare war on inflation hardline, “Long pain is worse than short pain. great strength.”