WASHINGTON ― The Federal Reserve is willing to risk higher unemployment if doing so can bring down prices.
The Fed announced Wednesday it had hiked interest rates three quarters of a percentage point ― the largest amount since 1994.
Higher interest rates put downward pressure on prices by making it more expensive for businesses and individuals to borrow money. When people have less money to spend, there’s less demand for goods and services, meaning less incentive for firms to hike prices.
If spending slumps significantly, however, companies may wind up laying off workers. People who lose their jobs spend even less, and it can become a self-reinforcing cycle ― known as a recession.
“You’re destroying economic activity and constraining economic growth in order to bring down prices, but in the process of doing that you’re artificially hurting the economy,” Jin Woo Chung, senior economist at Groundwork Collaborative, a progressive think tank, said in an interview.
Nearly 70% of economists surveyed by the Financial Times this week said they expect the U.S. to enter a recession in the next year because of the Fed’s aggressive action. Higher interest rates can affect the stock market immediately but may take months to ripple through the economy.
The central bank’s internal survey of its own board members and regional bank presidents, published Wednesday, indicated they expect the national unemployment rate to rise a tenth of a percentage point to 3.7% this year, 3.9% next year and 4.1% next year ― levels that do not suggest a recession.
Reserve Board chair Jerome Powell has said he thinks the labor market is strong enough to withstand higher borrowing costs without suffering widespread job losses. He said Wednesday that 4.1% unemployment with lower inflation would be a policy success, and insisted that the Fed doesn’t want to cause a recession.
Still, some job losses are undoubtedly part of the equation.
“We don’t seek to put people out of work,” Powell told reporters on Wednesday. “But we also think that you really cannot have the kind of labor market we want without price stability.”
Fed board member Christopher Waller suggested in a speech last month that higher interest rates would cut the number of job openings without resulting in too many layoffs.
The Fed started hiking interest rates earlier this year, but picked up the pace this week in response to persistently bad monthly inflation reports. Fed officials had previously said they would continue raising rates by half a percentage point, but opted for three quarters of a percentage point Wednesday. Powell said inflation had “surprised to the upside.”
Higher interest rates affect demand, but strong consumer demand has been just part of surging inflation over the past year. Powell noted that supply chain problems and the war in Ukraine, which has boosted prices for commodities such as wheat and oil, are outside of the Fed’s control.
“Our objective really is to bring inflation down to 2% while the labor market remains strong,” Powell said. “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.”
Chung criticized the Fed’s interest rate hike as a misguided response to inflation caused in large part by supply problems, arguing that a better policy would be for Congress and the White House to target corporate profiteering, since it’s corporate America that decides what prices to put on store shelves.
High prices burden everyone and have cratered consumer sentiment, but layoffs are especially devastating for the smaller number of households affected.
“A recession is harmful for everyone in many ways but the people who bear the larger brunt, the disproportionate harm of an economic downtown is historically the Black and brown communities and the economically disadvantaged,” Chung said.