New York (Reuters) – The Federal Reserve will face difficulties reducing inflation without a significant impact on the U.S.
Economic activity and a sharp rise in unemployment could prevent the central bank from reaching its 2% inflation target in the coming years, a group of renowned economists concluded after analyzing the difficulties central banks faced in the past in relation to inflation.
The study examined 16 cases since the 1950s, including 10 in the United States and others in Germany, Canada, and the United Kingdom, in which central banks used higher interest rates to generate a “disinflation,” which the research defined as a drop in the inflation rate of about 2 percentage points or more.
“We found no case in which significant central bank-induced disinflation occurred without a recession,” the researchers concluded.
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Among the study’s authors are Stephen Cecchetti, professor at Brandeis International Business School and former economist at the Bank for International Settlements (BIS); Michael Feroli, chief economist at JP Morgan; and Frederic Mishkin, professor at Columbia Business School, former Fed chair, and a longtime research collaborator of former Fed chair Ben Bernanke.
However, a series of rapid interest rate hikes carried out by the Fed last year which raised borrowing costs from near zero in March to a range between 4.5% and 4.75% at the central bank’s latest meeting has so far not brought significant negative consequences.
Some sectors of the economy, such as the housing market, were heavily affected by tighter credit; however, the unemployment rate remained stable and overall growth stayed resilient facts that Fed officials still see as signs of a possible “soft landing,” a scenario in which the economy slows without entering a recession.
In fact, analysts described the Fed’s most recent projections, released in December and expected to be updated in about four weeks, as “benign.”
The forecasts include inflation falling to 2.1% by the end of 2025, accompanied by economic growth and an increase in the unemployment rate to only about 4.6%.
In the authors’ view, “the cost of reducing inflation to the Fed’s 2% target by 2025 will likely be associated with at least a moderate recession.”
Although they acknowledge policymakers’ efforts to try to remedy the damage caused over the past year with faster interest rate hikes, they also project a difficult path ahead, in which reducing inflation will become progressively harder after an initial round of progress.
Their preferred model estimates that, with a benchmark interest rate peaking at about 5.6% this year already above the 5.1% projected by Fed officials in December inflation will fall to only 3.7% by the end of 2025.
Reference source: investing.com
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