WASHINGTON — The Federal Reserve’s war on inflation is set to enter a more complicated phase on Wednesday with greater risks for the economy — and for the central bank’s own credibility — as it tries to push prices down without causing large job losses.
Inflation appears to have peaked after a series of aggressive interest rate hikes by the Fed this year designed to tamp down the demand that has pushed prices so high. The latest signal came Tuesday, when the government reported that increases in the consumer price index slowed sharply in November, to a 7.1 percent annual rate, well below the four-decade high of 9.1 percent hit in June.
But that just means the easy work is over for Fed Chairman Jerome Powell and his colleagues, who are expected to announce another increase in the central bank’s benchmark interest rate Wednesday as they continue the difficult task of getting inflation back to normal without causing a recession. The hike comes despite criticism from Massachusetts Senator Elizabeth Warren and other progressives in Congress that Fed officials aren’t giving enough weight to the impact on average Americans who face job losses as rates continue to rise.
“I understand that Powell wants to bring inflation under control but not at the cost of putting millions of people out of work,” Warren said. “Crashing the economy will impose a lot of pain on a lot of people. It’s time to hit the brakes on these historic rate increases.”
Fed officials are expected to announce they will increase the rate by half a percentage point instead of the unusually large three-quarters of a percentage point hikes enacted at each of their last four meetings. A half percentage point increase would still be on the high side for the Fed, but Powell has said the job won’t be done until inflation is back to the Fed’s preferred 2 percent annual level.
“Despite some promising developments, we have a long way to go in restoring price stability,” Powell said at a Washington forum on Nov. 30, adding that high inflation is imposing “significant hardship” on many Americans.
The Fed, which is independent, is required to promote both price stability and maximum employment. There was strong support for the Fed to attack inflation with aggressive interest rate hikes this year, particularly after it got a late start because central bank officials initially thought higher prices would be just a temporary effect of the economy reopening after the pandemic
But now that inflation has been reined in somewhat, Powell is going to have to respond to concerns from Congress and within the Fed itself about how much further to go in the fight, said Diane Swonk, chief economist at audit and consulting firm KPMG.
“It’s black and white when you’re behind the curve, which is where they were. Now we’re in shades of gray,” Swonk said. “Goldilocks is a fairy tale. The economy isn’t going to land just right. It’s going to be too cold or too hot. And the Fed won’t know until it gets there.”
Some Fed officials have indicated they wanted to slow down the pace of rate hikes. And Powell has signaled that would happen at the Fed’s last meeting of the year, which ends on Wednesday with a formal announcement and a news conference by him explaining the decision.
But while the Fed is expected to ease up on the size of rate hikes, it’s not backing off. The benchmark rate, which began the year at near zero, is now up to a range between 3.75 percent and 4 percent. In September, Fed officials had forecast the rate would be 4.6 percent by the end of 2023, and could go even higher when they update their outlook for the coming year on Wednesday.
Warren and likeminded colleagues have warned that raising interest rates that high could push the economy into a recession and lead to large job losses. They’ve been pressuring Powell to slow down significantly, partly because interest rate increases won’t address other causes of inflation, such as the war in Ukraine and lingering supply chain problems from the pandemic.
“We don’t need another half-point raise that is not directed toward the factors that are forcing up prices in this economy,” Warren said Tuesday.
She joined 10 other members of Congress in a letter to Powell in October expressing concern about what they called the Fed’s “intention to continue raising interest rates at an alarming pace” and his warning that Americans should expect “some pain” in the process. That echoed a letter from Senate Banking Committee Chairman Sherrod Brown a few days earlier asking Powell not to forget “your responsibility to promote maximum employment.”
“I just think that the more aggressive they are the more difficult it is to keep the economy growing,” Brown said in an interview Tuesday.
But Senator Patrick Toomey, a Pennsylvania Republican on the Banking Committee who is retiring at the end of the year, said it would be premature for the Fed to stop the interest rate hikes.
“The data looks like we’ve reached peak inflation, but we’re nowhere near where it needs to end up so I think they need to stay on the course that they’re on,” Toomey said. “They can’t reverse course until this job is done.”
The competing pressures put Powell and the Fed in a difficult position. The Fed lost credibility in the 1970s when it failed to do enough to stop high inflation. It took then-Fed chair Paul Volcker pushing interest rates up to nearly 20 percent in the early 1980s to get inflation under control, but at a steep price: two recessions, including a particularly deep one that drove unemployment over 10 percent.
“I wouldn’t want to be in his chair right now,” Chris Rupkey, chief economist at FWDBONDS, a financial markets research company, said of Powell. “He’s literally threading the needle here, and there’s no economics textbook to tell him what to do.”
Job growth remains solid but has been slowing in recent months as interest rates have risen. The unemployment rate has ticked up to 3.7 percent, which still is historically low. The number of Americans receiving unemployment benefits has grown to 1.67 million, about 325,000 more than in mid-September.
But history has shown in places such as South America that the bigger risk for government central banks is letting inflation spiral out of control, which can cause severe recessions, Swonk said. Often, the failure to address inflation came by giving in to political pressure.
“This is not just the credibility of the Federal Reserve, it’s the credibility of Jay Powell,” she said. “People remember people who failed.”
But Powell has shown in the past that he will not give into political pressure. He held firm in 2018 when then-president Donald Trump publicly excoriated him for raising interest rates. Swonk doesn’t expect Powell and the Fed to deviate from its course now, either.
“History is littered with all these examples that show central banks made very poor decisions by bowing to political pressure,” she said. “The cardinal sin for any central bank is to let inflation become entrenched. And they don’t want to commit that cardinal sin.”