Just a week ago, we might reasonably have hoped that inflation was moderating and that Federal Reserve policy would, too. Sure, the war in Ukraine might have unpleasant effects on the prices of grain and fossil fuels, but presumably logistics wizards were unsnarling supply chains and consumers were working through the pent-up demand from the pandemic. Besides, hadn’t the Fed already raised interest rates drastically — 1.5 percent in just two short months? Surely we were already through the worst of it.
Then came last week’s nasty inflation report. Headline inflation didn’t look too bad, up just 0.1 percent from the month before thanks to falling gas prices. But food prices were soaring. And when you looked beyond volatile food and energy prices, you saw broad general upward pressure on prices, suggesting that there was more inflationary froth for the Fed to wring out of the economy. And the Fed is certainly signaling that it’s willing to put us through the wringer; on Wednesday afternoon, the monetary policy committee announced a third 0.75 percent interest-rate hike, adding that it “anticipates that ongoing increases in the target range will be appropriate.”
Translated into plain English, that means more hikes, and a lot more economic pain than we’re currently feeling — possibly including recession levels of agony.
You can already see the painful signs of slowdown if you know where to look. Mortgage rates topped 6 percent last week for the first time since the financial crisis, helping home sales continue a seven-month slide. Auto sales are slowing, too. Silicon Valley start-ups are cutting back as financing dries up, and even giants such as Meta and Google are reining in employee head counts. Most worrying, FedEx, which is a fairly reliable reflection of how everyone else’s business is doing, recently warned that it was likely to miss its earnings targets next quarter.
Normally, this is when the Federal Reserve’s monetary wonks would be looking for ways to ease us into a soft landing. Instead, they’re the ones tightening the screws. But it’s hard to blame them.
When inflation goes on too long, it can start to feed on itself. People and businesses expect to pay higher prices in the future, so they demand higher wages for their work and higher prices for their own goods. This, in turn, causes more inflation.
Once that toxic upward spiral of prices and expectations gets going, it’s very costly to stop. The last time the United States suffered a major bout of inflation, in the late 1970s, the Federal Reserve under Paul A. Volcker had to force the federal funds interest rate to nearly 20 percent in the following years to get the situation under control. More than one-tenth of the labor force ended up out of work. It was the country’s worst economic downturn since the Great Depression.
Higher interest rates got the balance between money and output back under control. But they also helped keep it under control because they sent a strong signal: The Fed is not playing around. If inflation creeps up, the institution will do whatever it takes to get it back under control. For 40 years, the Fed has maintained that credibility, which has helped the economy maintain price stability.
Now, for the first time in decades, that credibility is at risk, and the Fed is taking no chances. Fed Chair Jerome H. Powell and his monetary experts are clearly willing to err on the side of a mild recession rather than risk losing what Volcker bought them so dearly.
There’s one big way Powell’s job is easier than Volcker’s was: In 1980, the public had spent 15 years watching inflation creep up. Our current episode hasn’t even lasted 15 months. So it shouldn’t take anything like the pain the country endured in the 1980s to get it under control. But however much it takes, the Fed is clearly willing to deliver.