- The Fed's reversal of pandemic-era support is likely to slow the economic recovery.
- The economy is strong enough to stomach rate hikes and keep healing, Fed Chair Jerome Powell said Wednesday.
- "The probability of a recession within the next year is not particularly elevated," he added.
The Federal Reserve is walking a tightrope. Removing its economic support too slowly risks keeping inflation permanently high. Moving too quickly could throw the US into an entirely new recession.
Fed Chair Jerome Powell isn't particularly concerned.
The Federal Open Market Committee raised its benchmark interest rate on Wednesday, ending the near-zero rates seen throughout the pandemic and kickstarting a cycle of tighter monetary policy. The move is meant to place downward pressure on demand and cool inflation.
Yet higher rates will also tap the brakes on economic growth. After two years of buoying the pandemic-rattled economy, balancing the inflation fight with the broader recovery is now the Fed's biggest battle.
Economists critical of the Fed's approach have argued the central bank moved too late to ease inflation, and that catching up risks dragging the US into an economic downturn. Powell dismissed such concerns in a Wednesday press conference, arguing that the economy is in good shape, and it would take much more than the Fed's policy normalization to trigger a recession.
"In my view, the probability of a recession within the next year is not particularly elevated," Powell said. "All signs are that this is a strong economy, one that will be able to flourish — not to say withstand, but certainly flourish — in the face of less accommodative monetary policy."
The balance has to do with the Fed's dual mandate, which tasks the central bank with pursuing maximum employment and price stability. One of the two targets is already well on its way to being met: The labor market has recovered at a breakneck pace throughout the pandemic, to the point where there are now far more job openings than workers to fill them.
The inflation goal, however, hasn't been reached. Prices soared 7.9% in the year through February, a pace not seen since early 1982 and well above the Fed's target for 2% inflation. By reversing its ultra-accommodative monetary policy, the Fed is shifting its focus from the labor market's rebound to addressing the country's historic inflation problem.
Where Powell is optimistic that the economy can stomach the shift, others see a recession in the cards. Former Treasury secretary Larry Summers torched the central bank's strategy in a Tuesday column in The Washington Post, arguing the Fed is behind the curve in fighting inflation. The policy trajectory "is likely to lead to stagflation" and "ultimately to a major recession" as inflation stays high and unemployment worsens, Summers said, adding the Fed "has not internalized the magnitude of its errors over the past year."
Whether the Fed can walk the policy tightrope without stumbling remains to be seen. But some see Powell's Wednesday press conference as giving the Fed slightly more wiggle room. Though the 0.25 percentage-point rate increase was largely expected by economists, the central bank's updated economic projections show most officials expecting six more rate hikes in 2022. Powell also mentioned the Fed could start shrinking its balance sheet — a move that would further tighten monetary conditions — as early as May.
The comments hint the Fed could speed up its policy reversal if it needs to more aggressively fight inflation, Edward Moya, senior analyst at OANDA, said Wednesday.
"It seems the Fed sneakily somehow managed to scramble here to fight inflation and that is potentially removing the risk of a policy mistake," Moya said. "The economy could still end up in a recession next year, but at least the Fed positioned itself a little better to fend off inflation."