The US economy may struggle to escape recession, according to a Fed report on Friday. There is no historical precedent where a central bank has succeeded in fighting inflation without ‘economic sacrifice or substantial recession’.
Citing historical cases of ‘disinflation’ dating back to 1950 in major economies, the report concludes that central banks ‘will likely struggle to meet their disinflation targets without significantly sacrificing economic activity’.
This report, prepared by economists at a seminar organized in New York by the University of Chicago Booth School of Business, estimates that the American central bank (Fed) ‘will have to tighten its policy considerably to achieve its objective inflation by the end of 2025’. Inflation rose again in January, to 5.4% over one year, according to the PCE index published earlier on Friday, favored by the Fed and which it wants to bring back around 2%.
Late 1970s
The economy has in fact remained solid, despite the rate hikes the Fed has been carrying out for nearly a year, to increase the cost of credit and thus slow down consumption and therefore the pressure on prices.
The analysis identified parallels between the current climate and that of the late 1970s, when former Fed Chairman Paul Volcker drastically raised interest rates to counter soaring inflation. And, like 40 years ago, the Fed did not react soon enough, the report says.
The Volcker affair ‘shows how costly disinflation can be once a central bank has lost its credibility to control inflation’, the report’s authors write, recalling that it led to unemployment above 10% In the 1980’s.
So far, however, the job market has been solid, with the unemployment rate at its lowest, at 3.4% in January, and still a shortage of manpower. However, the “unprecedented” nature of the Covid-19 pandemic makes the current period distinct, pointed out Philip Jefferson, one of the Fed governors, during this seminar.
Economic models, ‘although still useful in many ways, are more difficult to apply’ and ‘must be used with careful interpretation and judgment’, he warned, warning of the need to’ scrutiny of real-time data.
/ATS