In terms of news on the economy and inflation, this is a big week. On Tuesday and Wednesday, Jerome Powell and his colleagues at the Federal Reserve will hold a two-day meeting, in which they are expected to raise the fed funds rate another three-quarters of a percentage point. On Thursday, the Commerce Department will release its initial estimate of GDP growth in the three months from April to June. Many economists expect a barely positive reading for inflation-adjusted growth, in the range of zero to one percent on an annualized basis. The Atlanta Fed’s GDPNow estimate, which incorporates a variety of economic data, predicts growth of minus 1.6 percent, or a decline.
If the GDP growth figure falls below zero, it will be the second negative quarter in a row and will generate more headlines about a recession. Although it is a commonly used rule of thumb that two quarters of negative growth means a recession, such headlines would be misleading. Powell and his colleagues, like the rest of us, are still struggling to understand a berserk economy hit by pandemic and war that shows mixed signs of strength and weakness. According to the Department of Labor, employers created 372,000 jobs in June, more than economists expected. Retail spending was also stronger than expected. In addition, the second-quarter GDP figure is likely to be negatively affected by unusual pandemic-related changes in corporate inventories, things that companies have made but not yet sold, which could well reverse in subsequent quarters. But even taking all of these factors into account, the economy has certainly slowed considerably this year, and looking ahead, a recession is a distinct possibility. So why is the Federal Reserve expected to raise interest rates, a policy designed to have a depressing effect on the economy?
The answer, of course, is inflation, which rose to 9.1 percent in June, the highest rate in more than forty years. Failing to predict the global rise in prices that began last year, central bankers around the world are egging each other on to slash interest rates. Last month, the Federal Reserve raised the federal funds rate by three-quarters of a percentage point. Earlier this month, the Bank of Canada outperformed its US sibling by raising its benchmark rate a full point. Last week, the European Central Bank (ECB) introduced a half point increase.
These rate hikes have come despite some signs that inflation may have peaked. In the last month, the price of crude oil has fallen back to roughly the same level as it was just before the Russian invasion of Ukraine. The price of gasoline has also dropped significantly. In June, the nationwide average price of a gallon of regular rose above $5 for the first time, according to AAA. The national average is currently $4.35.
Powell may well welcome these developments this week, but he is also likely to say that it is too early to change course. Despite the recent decline in oil prices, the Fed chairman and his foreign counterparts fear that inflation is spiraling out of control, just what independent central banks such as the Fed and the ECB set out to prevent. . “We may be reaching a tipping point, beyond which an inflationary psychology spreads and takes root,” the Basel-based Bank for International Settlements, which is a kind of central bank for banks, warned last month. central. Powell has gotten the message and seems determined to raise interest rates until inflation has subsided substantially for an extended period. “The risk is that. . . you start to make the transition to a higher inflation regime,” he warned a few weeks ago at an ECB forum in Portugal. “We will not allow a transition from a low inflation environment to a high inflation environment.”
Even as the Fed chairman has made aggressive comments like these, he has also insisted that a recession is not inevitable. In his press conference after last month’s Fed meeting, he said the US economy is “very strong and well positioned to handle tighter monetary policy.” But if the Fed and other central banks did such a poor job of predicting rising inflation last year, what reason is there to expect them to do exactly right from here on out? The honest answer is not much.
To his credit, Powell has publicly admitted the magnitude of the challenge facing him and his colleagues. At the forum in Portugal, he pointed out that the economic models on which they have long relied to analyze inflation – most notably the Phillips curve, which connects high inflation with low unemployment – have collapsed since the coronavirus pandemic it started. “I think we now have a better understanding of how little we understand about inflation,” Powell admitted.
It is not just inflation that is proving to be a puzzle. Minutes from the Fed’s June meeting suggest its officials are struggling to figure out how seriously to take all the talk of a recession. “The participants judged that the uncertainty about economic growth in the next two years was high,” the minutes state. “Some of them noted that GDP and gross domestic income had been giving mixed signals recently regarding the pace of economic growth, making it difficult to determine the underlying momentum of the economy.” That’s Fedspeak for “Right now, we’re stumped.”
In the face of all this confusion and uncertainty, Powell and his colleagues are probably relieved that they won’t have another meeting until the second half of September. By that time, what’s happening with inflation and growth should become clearer, or at least that’s what Fed officials will expect when faced with a decision on whether to moderate, or even pause, their rate hikes. interest rates. Considering the experience of the past two and a half years, you should expect the unexpected. ♦