Moneybox

Inflation Isn’t Going Back to Normal This Year

So says the Federal Reserve.

Close-up of Powell sitting in front of a mic
Federal Reserve Chairman Jerome Powell on Capitol Hill on March 3. Tom Williams/Pool/AFP via Getty Images

Since the start of this year, one of the biggest questions hanging over the economy was just how aggressively the Federal Reserve would move to try and bring down inflation.

Consumer prices have been rising at a pace not seen since the 1980s, thanks to the collision of strong consumer demand and never-ending supply chain issues. Chair Jerome Powell and his colleagues chose to spend most of 2021 standing back, waiting to see if inflation would ease up on its own.

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But as it persisted, the Fed signaled it was ready for action. Would the central bank resort to a “shock and awe” campaign of aggressively hiking interest rates in order to get a lid on prices? Or would it take a more measured approach, even if it meant inflation might not get back to normal this year?

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It was a high-stakes question. Inflation is the No. 1 economic problem in the view of the public. At the same time, if the Fed moves to hike rates and tighten credit too aggressively, it risks tanking the economy into a recession.

That’s what has tended to happen historically whenever the central bank has tried to play catch-up and quell inflation once it’s already begun to surge (in fact, some economists would argue that the only way the Fed can contain serious inflation is by inducing a recession that crushes consumer demand). The central bank’s task has only became more difficult thanks to Russia’s invasion of Ukraine, which sent the price of oil and other commodities soaring, as well as China’s recent COVID lockdowns, which threaten to further disrupt supply chains.

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Now we’re finally getting a look at the Fed’s approach—and the upshot is that while Powell and co. are taking steps to tamp down inflation, they’re also still trying to avoid rash steps that would bring about a downturn. On Wednesday, the central bank announced that it would raise interest rates by a quarter percentage point, its first hike since cutting them to zero at the start of the coronavirus crisis. Projections by members of the interest rate–setting Federal Open Market Committee anticipated six more hikes through the year, bringing it to just under 2 percent.

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The move was roughly in line with what the market expected. And as the New York Times wrote, “That small change carries a major signal: Policymakers have fully pivoted to inflation-fighting mode and will do what is necessary to make sure price gains do not remain hot for months and years to come.”

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At the same time, this was not what anybody would call shock and awe. In their forecasts, the vast majority of the FOMC’s members projected that inflation would still rise by 4 percent or more this year, well above the Fed’s official target of 2 percent. It also projected economic growth to remain relatively strong in the months and years ahead.

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The accuracy of these projections is less important than what they tell us about the Fed’s intentions: Our central bankers aren’t ready to do just anything to bring inflation down. They aren’t mentally gearing up to do their best impression of Paul Volcker, the Fed chair who plunged the U.S. into a painful double-dip recession in order to finally slay inflation early in Ronald Reagan’s presidency. Instead, they’re willing to tolerate moderate inflation for a while longer, with the hope that they can gently ease the economy toward a soft landing by the end of this year and beginning of next.

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When asked directly about the possibility of a recession during his press conference, Powell essentially waved it away, saying he didn’t think the risk of recession was particularly “elevated,” and that it was still possible to bring prices under control without causing higher unemployment. Not everyone may agree, but that’s the Fed’s stance right now.

Stocks rallied in response to the Fed’s decision and Powell’s performance; it gave investors a bit of relief that the Fed isn’t ready to tank the economy for the sake of price stability. The bad news, however, is that if you were hoping inflation might somehow get back to normal this year, our central bankers are warning that you’re about to be disappointed.

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