- The consequences of the Fed not being able to control inflation can be serious. Unemployment can spiral, with those on the lowest incomes bearing the brunt of the impact.
- Economist Joseph Brusuelas said the worst-case scenario would look like an unemployment rate of 5.5 percent and 3.5 million jobs lost.
- That the Fed is going too far and stifling the economy too much is the central fear of central bank critics.
- “I really think the war on inflation has been won. We just don’t know,” said Leuthold Group strategist James Paulsen.
Think of Federal Reserve Chairman Jerome Powell as a gymnast sprinting across the mat, spiraling, spinning, tumbling, then twisting in the air and trying to make sure he still lands perfectly on his feet.
This is monetary policy in this era of rapid inflation, slowing economic growth and heightened fears of what could go wrong. Powell is that gymnast standing on the budget version of an Olympic mat and has to make sure everything goes right.
Because if things go wrong, they can go very wrong.
“They need to stick to the landing,” said Joseph Brusuelas, chief U.S. economist at RSM.. “The bottom end of the economic ladder will bear the brunt if the Fed doesn’t properly stick to the landing. They’re losing jobs and their expenses are going down, and they’re having to draw on savings and 401(k)s to make ends meet.”
Users pressured by ever-increasing prices already dipping into savings to cover expenses.
The personal savings rate was just 3.5% in August, according to Bureau of Economic Analysis. That was slightly above the 3% level in June, which was the lowest level in 14 years, dating back to the early days of the financial crisis.
The prices of everyday items have soared at an incredible rate. Eggs rose 40% from a year earlier in August, butter and margarine jumped nearly 30%, and gasoline, even down 10.6% for the month, was still more than 25% higher than the same point in 2021 Mr.
The consequences of not getting it under control could be severe, just as they could be if the Fed goes too far in its quest to restore price stability to the US economy.
Brusuelas said the worst-case scenario would look like an unemployment rate of 5.5 percent and 3.5 million jobs lost as companies have to lay off workers to cope with the economic slowdown and rising costs that would come if inflation runs rampant.
The risk of failure
As it stands, the economy is very likely to head into recession anyway. The question is how much worse can it get.
“It’s not a question of whether or not we’re going to have a recession, it’s when we’re going to have one and the degree of intensity of the recession,” Brusuelas said. “My sense is that we are in recession until the second quarter of 2023.”
The Federal Reserve cannot simply keep raising interest rates while the economy weakens. It must grow until it reaches an equilibrium where it slows the economy enough to correct the multifaceted mismatches between supply and demand, but not so much as to cause deeper, unnecessary pain. According to The Fed’s latest outlookpolicymakers expect to continue in 2023 with benchmark rates around 1.5 percentage points from current levels.
“If the Federal Reserve overdoes it, you’re going to have a much deeper recession with higher unemployment,” Brusuelas said.
That the Fed is going too far and stifling the economy too much is the central fear of central bank critics.
They say there are tangible signs that 3 percentage point rate hikes so far in 2022 they have met their target and the Fed can now pause to let inflation fall and the economy recover, albeit slowly.
“The Fed can leave today and inflation will return to acceptable levels next spring,” said James Paulsen, chief investment strategist at The Leuthold Group. “I really think the war on inflation has been won. We just don’t know it.”
Paulsen looks at things like falling commodity prices, used cars and imports. He also said prices of technology-related items were falling while retail stocks were rising.
In the labor market, said the balance of wage growth this year it comes from the supply side of the economy that the Federal Reserve wants to stimulate, not the demand side that fueled the inflationary boom.
“If they want to, they can cause an unnecessary recession,” Paulsen said. “I just don’t know why they want to do it.
Paulson is not alone in his criticism. There are calls on Wall Street for the central bank to ease its policy tightening and watch the economy progress from here on out.
Wells Fargo head of equity strategy Christopher Harvey said the Fed’s announcements, particularly from Chairman Jerome Powell, were poised to inflicted “some pain” on the economy interpreted as the central bank’s desire to continue “until something breaks”.
“What is troubling is the apparent downplaying of capital market signals as the Fed moves toward its 2% inflation target,” Harvey said in a client note. “Therefore, these signals will need to get stronger (ie, stocks even lower and spreads wider) before the Fed reacts. It also means the recession is likely to be longer/severe than current fundamentals and market risk suggest.”
No less an authority than the United Nations issued on Monday a report of the agency in which Warned the United Nations Conference on Trade and Development of the effects that rising interest rates could have on a global scale.
“The current course of action is hurting vulnerable people everywhere, especially in developing countries. We need to change course,” UNCTAD Secretary-General Rebecca Greenspan told a news conference in Geneva, according to a Reuters account.
Still, the data suggest the Fed still has work to do.
The upcoming Consumer Price Index report is expected to show that the cost of living continued to rise in September. The Follow the Nowcast of the Cleveland Fed of items in the broad basket of goods and services that the Bureau of Labor Statistics uses to calculate the CPI showed another 0.5% increase, excluding food and energy, good for a 6.6% annual rate. Including food and energy, core CPI is expected to rise by 0.3% and 8.2% respectively.
While critics argue that these types of data are retrospective, the Federal Reserve faces an additional optical problem after downplaying inflation when it first started to rise significantly more than a year ago and was slow to act.
That puts the onus on policymakers to keep tightening to avoid a scenario like in the 1970s and early 1980s, when then-Chairman Paul Volcker had to plunge the economy into a deep recession to stop inflation once and for all.
“This is not the 1970s by any means for many reasons,” said Steve Blitz, chief economist at TS Lombard. “But I would say that they are still too optimistic that the rate of inflation will slow down on its own.”
For their part, Fed officials stuck to the company’s line that they were willing to do whatever it took to stop the price spike.
San Francisco Federal Reserve President Mary Daley spoke strongly about the human toll of inflation, telling an audience Tuesday that she heard about it from her constituents.
“Right now, the pain that I’m hearing, the suffering that people are telling me what they’re going through, is on the inflation side,” she said during a conversation in the Council on Foreign Relations. “They worry about their daily lives.”
Specifically on the salary issue, Daly said one person told her, “I run fast and fall behind every day. I work as hard as I can and fall even further behind.’