WASHINGTON — The Federal Reserve will launch on Wednesday one of the most difficult tasks a central bank can undertake: raise borrowing costs enough to slow growth and bring high inflation under control, but not so much as to tip the economy in recession.
With war raging in Europe and price increases at their highest level in four decades, Fed Chairman Jerome Powell will seek to engineer a “soft landing”: a gradual slowdown in economic activity that helps curb skyrocketing prices, while keeping the job market and economy growing.
Yet many economists worry that with soaring gas and commodity prices, the added burden of higher interest rates could completely stifle growth.
“You have to be both lucky and good” to avoid causing a downturn, said Alan Blinder, a Princeton University economist who served as the Fed’s vice chairman from 1994 to 1996, when the central bank was in power. widely seen as achieving a slowdown. landing.
As a first step, the Fed is expected to raise borrowing rates several times this year, starting this week with a quarter-point increase in its benchmark short-term rate. Policymakers will also discuss when and how quickly to cut the $9 trillion in bonds held by the Fed, a step that would also tighten credit for consumers and businesses.
Such moves mark a sharp reversal from the Fed’s ultra-low rate policies, which it adopted when the pandemic recession hit two years ago. By setting its policy rate near zero for two years and buying trillions of bonds, the Fed has kept borrowing costs at historic lows and helped push stock prices higher.
The Fed, by its own admission, underestimated the magnitude and persistence of high inflation after the pandemic hit. Many economists say the central bank made its job riskier by waiting too long before starting to raise rates.
The average 30-year fixed mortgage rate, which hit a record low of 2.65% in January 2021, has risen to 3.85% over the past three months as Powell signaled Fed intentions and inflation soared.
By raising short-term rates, the Fed hopes to make it more expensive to buy homes and cars and to raise credit card rates and borrowing costs for businesses. The resulting decline in spending should, in turn, slow inflation, Powell told Congress two weeks ago. Strong consumer spending, fueled by stimulus and steady increases in hiring and wages, has come up against supply shortages to push inflation to 7.9%, the highest rate since 1982.
“People will spend less, and what we hope to achieve is to get the economy to a level where demand and supply are in sync,” Powell told a Senate Banking Committee hearing.
If the Fed is successful, he said, the economy should continue to grow and unemployment, over time, should remain low — it is now 3.8% — or fall further.
“I think it’s more likely than not that we can achieve what we call a soft landing,” Powell told a House panel a day before his Senate testimony.
The sharpest soft landing came in 1994 and 1995, when the Fed under Chairman Alan Greenspan raised its benchmark rate from 3% to 6% as the economy rebounded from a brief recession. Inflation, which was not a problem at the time, has come down further. And unemployment stabilized at around 5.5% before resuming its decline two years later.