Concerns about a looming recession are on the rise as the Federal Reserve embarks on an aggressive campaign to raise interest rates. This move has sparked questions from politicians and the public about why central bankers are willing to potentially harm the economy. The short answer: It’s a necessary tool to control inflation.
The Federal Reserve’s primary goal is to manage inflation and one of the ways it does this is by raising interest rates. By increasing interest rates, the Fed aims to make borrowing more expensive, affecting mortgages, auto loans, and business borrowing. As the cost of borrowing money rises, it puts downward pressure on spending and hiring, which, in turn, can weaken the job market and the broader economy. Slower economic growth helps balance the supply and demand equation, ultimately curbing inflation.
The adjustment process, however, can be quite unpleasant. Stock prices start to fall, property sales slow down, and unemployment tends to rise. The Fed acknowledges that this transition can be rocky, with the risk of a recession looming.
Federal Reserve Chair Jerome H. Powell emphasized during recent testimony before senators that monetary policy is a blunt tool. While it can help control inflation, it may lead to weaker economic outcomes. Nevertheless, Powell stressed that a recession is not the Fed’s intention.
Simultaneously, Fed officials argue that not addressing inflation and allowing it to spiral out of control would be a more significant problem. The current inflationary pressures are significant and affect everyone, making it crucial to act decisively.
The Federal Reserve contends that it might be able to slow down the economy enough to moderate inflation without pushing demand to a level that triggers a recession. In their latest projections, central bankers anticipate a slight increase in unemployment this year and the next but not a sharp rise.
However, achieving this soft landing is far from guaranteed. Ongoing economic shocks, such as the war in Ukraine driving up food and fuel prices or Chinese pandemic-related lockdowns disrupting factory production, may force the central bank to further reduce demand to align it with the limited supply of goods and services.
Federal Reserve Chair Powell acknowledges the risk of a recession but emphasizes that it’s not their intent. He stated that recent global events have made it more challenging to achieve their dual mandate: maintaining 2% inflation and fostering a strong labor market.
In summary, the Federal Reserve’s decision to raise interest rates is driven by the need to control inflation, even if it involves some economic discomfort. The central bank believes that the potential risks of unchecked inflation outweigh the possibility of a recession and remains committed to achieving its economic goals while managing inflationary pressures.