Home Nonmilitary action Hawkish Fed interest rate hike raises recession risks

Hawkish Fed interest rate hike raises recession risks

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As expected, Federal Reserve Chairman Jerome Powell announced a third consecutive three-quarters percent interest rate hike on Wednesday. Rising interest rates will increase borrowing costs for businesses and home buyers. This could potentially slow economic growth and employment. And that could push the United States into a recession.

Last year, Powell called inflation “transitional,” but the Federal Reserve has struggled to bring it down to manageable levels. Russia’s war in Ukraine has sent global energy and food grain prices skyrocketing. Gas prices have since fallen and global supply chain issues have eased. But rising labor costs due to a highly competitive labor market remain a major driver of high inflation.

The two main tasks of the Fed are to control inflation and to enable full employment. In a statement today, the Fed’s monetary policy governing body, the Federal Open Market Committee (FOMC), called job growth “robust” and stressed that it was “strongly determined to bring inflation back to its target of 2%”.

Recession risks rise as soft landing looks elusive

The price to pay to bring inflation back to that 2% target could be a recession.

In a study published last week, the World Bank said that a global recession could be in store for 2023 as central banks raise interest rates “with a degree of synchronicity not seen in the past five decades.”

The Federal Reserve and other central banks use interest rates as leverage to cool or stimulate economic activity. Rising inflation is a sign of an overheated economy. Raising interest rates can slow economic growth to more manageable levels that allow price stability. Central banks can also raise interest rates – one of their expansionary tools – to help a struggling economy regain momentum.

Governor Jerome H. Powell testifies before the Senate Banking, Housing, and Urban Affairs Committee. In May 2022, the Fed announced the largest interest rate hike in 20 years. (Image credit: Federal Reserve)

According to the World Bank, central banks may need to raise interest rates by another 2% to bring inflation back to target. Powell signaled that further increases may be on the way.

Although a recession is far from certain, certain sectors, including housing, will continue to be affected. In August, sales of existing homes fell for the seventh consecutive month, according to the National Association of Realtors. In August, sales fell nearly 20% from a year earlier. The average rate for a 30-year fixed rate mortgage is now above 6%.

Can Powell retire a Captain Sully?

Powell’s challenge is to use the tools at his disposal to drive down interest rates without triggering a recession, ensuring a “soft landing” for the economy.

But there is a lag in the time it takes for interest rate changes to have an impact on the overall economy. So it’s a bit like shooting in the dark. By raising interest rates, it could overcorrect and drag the country unnecessarily into a recession. But if he is not vigilant enough, inflation could become a longer-term challenge and the United States could find itself locked in a period of stagflation like in the 1970s.