Over the last 14 months, the Federal Reserve has taken a deliberate and economically painful approach to combating elevated inflation rates through interest rate hikes. The regional banking crisis and a possible debt-ceiling induced default on US debt could change all of that.
What's happening: There are two policy options that the Fed can use to address elevated inflation. It can systematically raise interest rates in order to induce price stability, or it can practice opportunistic monetary policy. That's when instead of hiking interest rates and tightening policy, policymakers simply do nothing but wait.
Proponents of the opportunistic approach say that when inflation is moderate (but still above the Fed's 2% long-term objective), policymakers shouldn't take any deliberate action to lower inflation and should instead wait for some sort of external circumstance like a recession to reduce inflation on its own.
"It does sound kind of weird," acknowledged Laurence Ball, an economist at Johns Hopkins University who helped popularize the concept in the 1990s. "The idea is that if you don't slow the economy on purpose, at some point the economy will slow accidentally and then inflation will go down."
Former Philadelphia Fed President Edward Boehne put it this way: "Sooner or later, we will have a recession. I don't think anybody around the table wants a recession or is seeking one, but sooner or later we will have one. If in that recession we took advantage of the anti-inflation [impetus] and we got inflation down from 4.5% to 3%, and then in the next expansion we were able to keep inflation from accelerating, sooner or later there will be another recession out there."
Interest rates are hovering at levels high enough to moderate economic activity and inflation has eased off of its June 2022 peak. Some economists think it's time for the Fed to take their hands off of the steering wheel.
Investors seem to agree — the market has priced in a 72% chance of a pause in interest rate hikes at the next policy meeting in June, according to the CME FedWatch Tool.
The opportunity: It doesn't hurt that the regional banking crisis and threat of a debt-ceiling induced default have already created economic headwinds that could bring down inflation.
Federal Reserve Chair Jerome Powell even noted last week that the collapses of Silicon Valley Bank and Signature Bank had done some of his work for him.
Speaking during a panel discussion with former Fed chair Ben Bernanke, Powell noted that interest rates might not have to rise "as much as they would have otherwise to achieve our goals" because banking turmoil has already led to tighter lending conditions.
The debt ceiling crisis, said Ball, could also act as a disinflationary event. "It could end up being just what's needed to slow the economy down," he said, noting that there's still a lot of uncertainty around how negotiations play out.
Federal Reserve Bank of Chicago President Austan Goolsbee noted in an interview with Yahoo Finance in early May that the debt ceiling debate would likely lead to even tighter credit. "We have to figure out how much of the work of monetary policy is getting done already through the credit conditions," he said.
Some doubts: The reduction in inflation after recessions, he found, has varied considerably. A credible disinflation policy put into place by the Fed delivers faster, more consistent results.
The thought that some sort of natural intervention will stabilize prices with minimal pain is a nice one, said Julian Brigden, co-founder and president of Macro Intelligence 2 Partners, but it's not very realistic. And nobody wants the economic catastrophe that an actual US default would entail.
Still, it appears that the mere threat of one could finish the Fed's job for it.
Comments
Post a Comment