(Bloomberg) -- Federal Reserve Chair Jerome Powell took a step toward assuming the mantle of inflation slayer Paul Volcker, all but acknowledging that reining in run-away price pressures may result in a recession.
Declaring that it’s essential to bring inflation down, Powell engineered the central bank’s biggest interest-rate increase since 1994 on Wednesday and held out the distinct possibility of another jumbo three-quarter percentage point increase in July.
He openly endorsed for the first time raising rates well into restrictive territory with the aim of cooling off the labor market and pushing joblessness up -- a strategy that in the past has often resulted in an economic downturn.
‘This is a Volcker-esque Fed,” said Diane Swonk, chief economist at Grant Thornton LLP. “That means the Fed is willing to take a rise in unemployment and a recession to avert a repeat of mistakes of the 1970s. Supply shocks won’t correct themselves, so the Fed must reduce demand to meet a supply constrained world.”
The shift in stance carries perils not only for the economy, but for financial markets and President Joe Biden. Stocks have tumbled in recent months as the Fed has tightened credit to get on top of inflationary pressures that have proved more persistent and widespread than it expected. While the markets took Wednesday’s rate increase in stride, they remain fragile.
Biden has seen his popularity plunge as inflation has soared. A recession -- and the higher unemployment that would bring -- would rob the president of one of his few talking points in touting the benefits of his policies for the economy.
Powell is likely to be grilled by lawmakers next week on why the Fed misjudged the severity of inflation and why it now believes there will be costs to eradicating it when he presents the central bank’s semi-annual review of monetary policy to Congress.
Ex Fed Chair Volcker is lionized within the Fed for breaking the back of double-digit inflation 40 years ago. What’s not always mentioned is that he had to put the economy through the wringer to do that -- unemployment soared above 10% on his watch -- and that his policies provoked a populist backlash from home builders and others who were particularly hard hit by the credit squeeze.
Unlike Volcker, Powell said the Fed was not out to drive the economy into recession. But he effectively admitted that a downturn was possible, though he argued that it wouldn’t be the Fed’s fault.
“Our objective really is to bring inflation down to 2% while the labor market remains strong,” Powell told reporters. “I think that what’s becoming more clear is that many factors that we don’t control are going to play a very significant role in deciding whether that’s possible or not,” in particular Russia’s invasion of Ukraine and the potentially extended impact that could have on energy and food prices.
An increasing number of economists are projecting a downturn next year as the Fed struggles to get on top of inflation that’s running at its highest level in four decades. Nearly 70% of academic economists polled by the Financial Times and the University of Chicago foresee a contraction in gross domestic product next year, according to survey released June 13.
Fed policy makers’ projections released after the meeting show the economy continuing to grow this year and next, though at a subpar pace. But they also foresee unemployment rising, something that usually only happens during a recession: Joblessness is forecast to rise to 4.1% at the end of 2024 from 3.6% now, according to the median forecast.
While maintaining that a 4.1% jobless rate would still be historically low, Powell made clear that the Fed’s No. 1 goal was not tending to the labor market but getting inflation under wraps.
“I will begin with one overarching message,” the Fed chair said at the start of his press conference. “We’re strongly committed to bringing inflation back down, and we’re moving expeditiously to do so.”
To that end, policy makers are projecting a steep rise in interest rates in coming months. They now see the federal funds rate they control rising to 3.4% by the end of this year and 3.8% at the end of 2023. That’s well above the 2.5% rate they reckon is neutral for the economy -- neither spurring nor restricting growth -- and compares with the current fund’s rate target of 1.5% to 1.75%.
But even that won’t be enough to bring inflation fully back to the Fed’s 2% goal. It’s projected to end 2024 at 2.2%, compared with 6.3% now.
Powell in particular stressed the importance of keeping inflation expectations in check and said that was one reason the Fed abruptly decided to raise rates by three-quarters of a percentage point Wednesday, instead of the half-point increase it had been telegraphing for weeks.
It was an un-anchoring of inflation expectations that bedeviled Volcker and forced him into delivering such harsh monetary medicine to bring price gains under control, at one point pushing interest rates as high as 20%. Consumers, workers and businesses back then were convinced that inflation was headed ever higher, and so acted in ways that helped bring that about.
Powell said that’s why policy makers can’t ignore run-ups in oil and food prices, even though they are outside its control. They affect how Americans view the outlook for inflation.
“Powell is determined not to repeat the mistakes of Arthur Burns, who led the central bank during the wage-price spiral of the 1970s” and preceded Volcker as Fed chair, Anna Wong, Chief U.S. Economist for Bloomberg Economics, said in a note. “Officials now appear to acknowledge that inflation is a real problem, and they are increasingly recognizing and accepting the costs that will come with tighter monetary policy. “