NEW YORK (Reuters) – The Federal Reserve will face difficulties reducing inflation without a significant impact in the U.S.
Economic activity and a sharp rise in unemployment could cause the central bank to miss its 2% inflation target in the coming years, a group of renowned economists concluded after analyzing the difficulties central banks have faced in the past regarding 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 “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.
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 chairman, and longtime collaborator on research with former Fed chairman Ben Bernanke.
But a series of rapid rate hikes by the Fed last year, which pushed borrowing costs from nearly zero in March to a range between 4.5% and 4.75% at the central bank’s last meeting, has so far been relatively cost-free.
Some parts of the economy, such as housing, have been hit hard by tighter credit, but the unemployment rate has not budged and overall growth has remained resilient — facts that Fed officials still regard as evidence of a possible “soft landing,” in which the economy weakens without falling into recession.
Indeed, researchers said they viewed the Fed’s most recent projections, released in December and expected to be updated in about four weeks, as “benign.”
Projections include a drop in inflation to 2.1% by the end of 2025, along with economic growth and an increase in unemployment to only around 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 officials’ efforts to try to remedy the damage caused over the last 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 the benchmark interest rate peaking at around 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.
Source reference: investing.com
