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The Federal Reserve Chair Takes a Contrarian Bet on Recession

The Federal Reserve’s attempts to slow down the economy and control inflation have been likened to the descent of an airplane, with potential outcomes ranging from a smooth landing to a turbulent one or even a catastrophic crash.

Fed Chair Jerome H. Powell, however, is placing his bets on a scenario resembling the Miracle on the Hudson: a gentle touchdown that, all things considered, defies expectations and stands out from anything the nation has witnessed before.

Over the past year, the Fed has implemented significant interest rate hikes, pushing them just above 5 percent on Wednesday, in an effort to cool down the economy and rein in inflation. Economists at the central bank have recently begun forecasting that the United States is likely to enter a recession later this year due to the combined impact of the Fed’s substantial policy actions and the turmoil within the banking sector, which could stifle economic growth.

However, Mr. Powell made it abundantly clear during a news conference on Wednesday that he does not share this viewpoint.

“That’s not my own most likely scenario,” he said, while explaining his expectation of modest growth this year. His optimistic forecast is partly based on trends observed in the labor market.

Despite displaying signs of cooling, America’s job market remains robust, with rapid job growth and unemployment hovering near a 50-year low. However, job openings have experienced a sharp decline in recent months, dropping from over 12 million a year ago to 9.6 million in March. Normally, such a significant reduction in available positions would be accompanied by layoffs and rising joblessness, leading prominent economists to predict a painful economic downturn.

However, unemployment has yet to show any significant increase. “It wasn’t supposed to be possible for job openings to decline by as much as they have without unemployment going up,” Mr. Powell commented this week. Although the latest unemployment figures will be released on Friday, there has been no meaningful rise in unemployment thus far. Mr. Powell further noted that “there are no promises in this, but it just seems to me that it is possible that we can continue to have a cooling in the labor market without having the big increases in unemployment that have gone with many prior episodes.”

The economic fate of the United States hinges on the accuracy of Mr. Powell’s optimism. If the Federal Reserve can defy historical patterns by significantly cooling the labor market to control inflation without causing a substantial increase in joblessness, the legacy of the post-pandemic economy could be a tumultuous yet ultimately positive one. However, failure to achieve this delicate balance could result in a painful cost for American employees in their struggle to tame price increases.

In such circumstances, the Federal Reserve raises interest rates to cool down both the economy and the job market. Higher borrowing costs slow down the housing market, discourage significant consumer purchases like cars and home improvement projects, and deter businesses from expanding. As people reduce their spending, companies find it challenging to raise prices without losing customers.

However, setting the correct policy is akin to walking a tightrope in the economy.

Policymakers believe it is crucial to act decisively enough to swiftly bring inflation under control. Allowing inflation to persist for too long may lead families and businesses to anticipate consistent price hikes. Consequently, they may adjust their behavior by demanding higher wages and normalizing regular price increases. This would exacerbate the challenge of stamping out inflation.

On the other hand, officials are wary of cooling the economy excessively, as it could result in a painful recession that proves more severe than necessary to restore inflation to normal levels.

Finding the right balance is a precarious proposition. The exact extent to which the economy needs to slow down to effectively control inflation remains unclear. Moreover, the Federal Reserve’s interest rate policy is a blunt and imprecise tool that takes time to yield results.

The Federal Reserve has taken a cautious approach in recent months, slowing down its policy changes and considering a complete pause. After implementing a series of three-quarter point rate adjustments last year, the Fed has now shifted to making quarter point changes in borrowing costs. Officials have indicated that they might cease raising rates altogether at their mid-June meeting, depending on incoming economic data. This pause would allow central bankers to assess whether the rate adjustments made so far have been effective.

Furthermore, the Fed would use this time to evaluate the consequences of the banking industry’s turmoil, which could complicate achieving a soft economic landing. Since mid-March, three major banks have collapsed and required government intervention, causing concern among midsize lenders. On Wednesday and Thursday, several regional bank stocks experienced significant declines. Banking problems can quickly translate into economic issues as lenders retract, making it harder for businesses to grow and families to finance their consumption.

Given the ongoing bank tumult and the Fed’s rate adjustments, the labor market could experience a more pronounced slowdown, according to Nick Bunker, the director of North American economic research at job site Indeed. He suggests that while job openings have been declining rapidly, some of this decline may be due to a return to normal conditions following the unusual circumstances brought about by the pandemic, rather than solely influenced by Fed policy.

For example, job openings in the leisure and hospitality industries surged as restaurants and hotels reopened after lockdowns. However, those job openings are now dwindling, which may be attributed to a return to business as usual rather than an effect of the Fed’s actions.

Mr. Bunker metaphorically compared the current situation to a soft landing, questioning how much of the landing is influenced by gravity (external forces) versus the actions of the pilot (Fed policy). Moving forward, it is possible that the conventional relationship between declining job openings and rising unemployment, observed in previous instances, will manifest as the impact of the Fed’s policy measures becomes more apparent.

However, there is also the possibility that this time could be truly unique, as Mr. Powell hopes. Whether the Fed and the American economy will have the opportunity to test his thesis depends on resolving the issues within the banking system, as highlighted by Mr. Bunker.

“If the financial sector comes and tips the table over,” he cautioned, “we might not get the answer.”

Editor PSCKS News

Editorial board member of PSCKS News. Our mission is to share authentic local news and some healthy lifestyle things.

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