- Powell aims to balance inflation and recession.
- Interest rates expected to decrease to 0.25%.
- Private economists predict 65% chance of contraction, but consumer spending remains strong.
Federal Reserve Chairman Jerome Powell faces the challenge of balancing inflation control and avoiding a recession. He is determined to avoid the mistakes of his predecessors, ex-Fed chief Arthur Burns and Paul Volcker. Burns allowed inflation to get out of control in the 1970s by not tightening monetary policy enough, while Volcker defeated double-digit inflation in the 1980s but caused a painful economic downturn that increased unemployment.
Powell's goal is to establish himself as a leader who neither reversed too soon like Burns nor caused a recession like Volcker. Policymakers are expected to decrease the interest rate hike to 0.25% this week as they search for a balance between controlling inflation and avoiding a recession. Powell will also emphasize the need to keep rates elevated for some time and not ease policy until inflation is under control.
There are many risks involved in this hybrid strategy. A flare-up in oil prices and inflation due to China's reopening of its economy could force the Fed to reconsider rate hikes. Conversely, unemployment could increase more than expected as the Fed maintains a tight policy stance to combat inflation. Despite the challenges, Fed officials from both policy spectrums have expressed more optimism about the central bank's ability to achieve a soft landing, where price gains are moderated without hurting the economy. The Biden administration is also confident in the Fed's ability to get policy right. A recent fall in inflation, slowed wage growth, and resilient consumer spending have all contributed to the optimistic outlook.
However, private economists are not as optimistic. They predict a 65% chance of a contraction in the next year. The housing market is already in recession, and manufacturing has also slowed due to global economic issues and a shift in consumer spending. Nevertheless, consumer expenditures have remained strong, despite sky-high inflation, as households draw on their pandemic savings and benefit from a strong job market. However, there were signs of consumer spending slowing down at the end of 2022 as adjusted personal spending dropped 0.3% in December. The consumer spending engine may begin to sputter, according to Deutsche Bank's chief US economist, Matthew Luzzi.