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Why the Fed’s inflation fight may end in all pain and no gain

Calls for the central bank to stop raising interest rates are growing louder. But is it too late to avoid a recession?

Inflation can make grocery shopping an unpleasant experience.Nam Y. Huh/Associated Press

This column first appeared in Trendlines, my new business newsletter that covers the forces shaping the economy in Boston and beyond. If you’d like to receive it via e-mail on Mondays and Fridays, sign up here.

What’s worse, the pain of sharply rising consumer prices or the pain caused by the Federal Reserve’s cure — sharply higher interest rates?

We may soon find out.

Until recently the answer seemed straightforward. A rapid spike in borrowing costs over the past 13 months had slowed inflation without the feared side-effect of a surge in unemployment.

But Fed chair Jerome Powell says that despite the progress, inflation remains too hot, especially in the service sector. After last week’s robust jobs report, he and his central bank colleagues are poised to boost their benchmark lending rate by another quarter of a percentage point when they meet on May 2-3.


Just about everyone else, however, says that inflation is clearly in retreat and that Powell & Co. should take a breather to see if the trend continues on its own. That’s preferable, they say, to the risk of triggering a job-destroying recession by tightening the credit screws too hard.

The “wait-and-see” argument took on added urgency following the failures last month of Silicon Valley Bank and Signature Bank, and the emergency rescue of Credit Suisse by UBS. Other lenders, seeking to protect their capital, may make fewer loans, potentially causing a credit crunch that could have the same deflationary effect as a rate increase.

“The Fed has already done a lot and should let the effects of its rate hikes work through the economy,” Claudia Sahm, a consultant and former central bank economist who has repeatedly urged the Fed to pause, said in a Substack post last week. “Even before the failure of Silicon Valley Bank kicked off a wave of banking turmoil, banks were already tightening their standards (making it hard to get loans),” Sahm wrote.


Even Larry Summers, the Harvard economist who has argued against a pause, said it’s far from obvious what the Fed should do next.

“Whether there’s going to be another move necessary or not, I think that’s a judgment they should be holding off on until the very last. . . moment,” he said Friday in an interview on Bloomberg TV’s “Wall Street Week.”

When comparing the consumer price index on a year-over-year basis, inflation soared 9.1 percent last June, the fastest since the early 1980s. By February, the pace had slowed to 6 percent, and forecasters expect the March reading, set for release on Wednesday, to show a further deceleration to 5.1 percent. The Fed targets 2 percent inflation.

On Friday, the Labor Department said US employers added 236,000 jobs in March. That was down more than 100,000 jobs from the average gain over the prior six months, but still well above prepandemic levels, suggesting that the labor market is strong enough to absorb another rate hike aimed at further driving inflation toward 2 percent.

“It’s not that the Fed ‘should’ aim for higher unemployment, it’s that the only thing holding it back from much higher interest rates was fear of employment losses,” Harvard economist Jason Furman told me in an e-mail. “Those fears are a little smaller [after the jobs report] so it has more room to raise rates without as much real economic fear.”


Still, “I’m not completely sure they should do [a quarter-point increase] at the next meeting,” he said. “Having a pause on the table is completely reasonable.”

But is it too late for a pause to make a difference?

That’s what futures prices that reflect investors’ outlook for Fed interest rates are signaling. Investors are betting that the Fed will cut rates by a full percentage point by January.

Why? To soften the blow of a recession that many economists believe is unavoidable this year.

That scenario contrasts with projections that the Fed issued last month. Fed officials said they expect to lift their benchmark rate by a quarter point to a range of 5 to 5.25 percent, then leave it there for at least the rest of the year. Unemployment will rise but the economy will dodge a recession, according to their forecasts.

Sahm, the former Fed economist, isn’t buying the Fed’s outlook. She has noted that the central bank’s own forecast calls for the jobless rate to reach 4.6 percent this year from 3.6 percent in March. An increase of that size has always preceded a recession.

“It’s no longer the most likely path,” she wrote last week, referring to the Fed’s goal of a “soft landing” in which inflation comes back to earth without a painful loss of jobs. “And it will be even less likely without a pause.”


Which is worse, inflation or the cure? I guess we will find out soon.

Larry Edelman can be reached at Follow him @GlobeNewsEd.