- Economic specialists believe that the authorities should raise the rate higher than expected.
- Based on a predictive model, the experts consider that there is no possibility of a “soft landing”.
- The Federal Reserve was quick to respond to these economists’ assertions.
Unless there are changes in the Federal Reserve’s (Fed) current fight, it will have negative consequences for the U.S. economy. That is the conclusion reached by a group of experts led by former Fed Governor Frederic Mishkin. In a recent publication, he and a group of economists warn that recession will come despite efforts for a soft landing.
Mishkin, who now serves as a professor at Columbia University, was emphatic in the pages of the article. Together with his colleagues, he dismisses the possibility of a “soft landing” in the face of contraction and asserts that the current rate hike cycle will have to be extended. For this, they rely on a predictive model that analyzes historical experiences of inflation cooling by the central bank.
Thus, once the cycle of interest rate hikes is over, the recessionary phenomenon will occur in the economy. It should be noted that the current forecast for the rate hike is between 4.5% and 4.75%. However, the article expects that at the end of the day the price of money will exceed 5%. On the other hand, some voices speak of the need to take it up to 6% or more.
In any case, the possibility of a soft landing, which seemed to excite a few weeks ago, is now being diluted by the rise of the more pessimistic outlook.
No price cooling without recession
There are many reasons to assume that the contraction of the economy will be an inevitable phenomenon in the coming months. For the cited article, recession will come for the simple fact that there is no possible recipe for cooling consumer prices without damaging the economy. Historical data, he explains, do not show any case in which the economy has come out unscathed after central bank maneuvers to lower inflation.
“There is no post-1950 precedent for substantial central bank-induced disinflation that does not involve substantial economic sacrifice or recession,” they say. One should not lose sight of the fact that this scenario was already showing up with the current rate hike forecast. Consequently, if the Fed is forced to make additional increases, the possibility of a contraction would have little argument against it.
It is in this context that analysts begin to fear the worst. This is because the labor market numbers and economic growth are not going as expected. In other words, effectively lowering prices requires consumers to spend less, so unemployment is a necessary tool. Nevertheless, the employment market looks stronger than the authorities would like. Despite showing some fractures, corporate layoffs are not enough to push up unemployment.
Given that inflation is receding at a very slow pace and employment and retail sales remain solid, the Fed will have no choice but to increase its aggressiveness. The latter leaves no room for soft landing which means that recession will come with little or no opposition.
The current cycle will not lead to a fall in the CPI
The interest rate hikes that began in March of last year are intended to bring inflation down to 2%. The Fed believes that bringing rates to the range between 4.5-4.75% will be enough to reach that 2% which is the central bank’s target for the consumer price index. But not everyone agrees with that assumption.
One of the critics is Ken Rogoff, a Harvard economist. For him, the Fed will have to raise the rate to 6% in order not to miss all the 2022 monetary policy moves. If not, then the central bank’s 2% inflation target will not be met. Currently, the Fed’s favorite inflation index (consumer spending price index) is at 5.4% year-over-year, according to January figures.
The authors of the cited article base their assessment on a historical economic situation analysis model. The data indicate that the Federal Reserve will have to tighten its monetary policies to reach the target by 2025. If inflation will fall back to the central bank’s 2025 target, that translates into bad news for the economy and for financial markets in the meantime.
Meanwhile, economists agree that recession will come in the interim between monetary policies and the pullback in inflation.“Even assuming stable inflation expectations, our analysis casts doubt on the Fed’s ability to engineer a soft landing in which inflation returns to the 2% target by the end of 2025 without a mild recession,” they note.
Fed reaction to the article
The article published by these experts did not amuse the representatives of the U.S. central bank, who were quick to respond. Such is the case of Federal Reserve Governor Philip Jefferson, who made a public appearance to criticize the work of the specialists. Although he assured that his words are a personal point of view and not the response of the Federal Open Market Committee (FOMC), it was published on an official website.
In any case, the official wasted no time in highlighting what he considers to be a high level of inaccuracy in the academics’ model. In his opinion, the current conditions that caused high inflation have no point of comparison in history. Therefore, the academics’ model, although correctly applied, would not be pointing to the true probabilities of outcome.
“History is useful, but it can only tell us so much, particularly in situations without historical precedent,” he said. On the other hand, he acknowledged that some arguments such as that disinflation can be costly for the economy are valid. “And while one can question the details, his argument that policymakers should accept that disinflation is likely to be costly is reasonable,” he stressed.
Predictably, the point that Fed officials reject is the one about a recession that will inevitably come. Since the FOMC, the various governors are convinced that a soft landing is quite possible. It is worth mentioning that a soft landing is a situation in which the authorities manage to defeat inflation without causing major problems to economic growth.
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