As inflation gathered force in 2021 and 2022, the Federal Reserve notoriously waited too long to raise interest rates, allowing consumer prices to continue to climb sharply, Fed officials now acknowledge.
Now that inflation is easing, the Fed may be poised to make another blunder by moving too slowly to cut rates and triggering a recession, some economists argue.
“The longer they wait, the greater the risk that something goes off the rails,” says Mark Zandi, chief economist of Moody’s Analytics.
With annual inflation drawing closer to the Fed’s 2% goal and some risks to the economy growing, Zandi says the Fed should start lowering rates in March, or May at the latest. Inflation is running around 3% or slightly below, based on the two most popular measures, down from a 40-year high of up to 9.1% in June 2022.
But Fed Chair Jerome Powell said last month that a March cut is highly unlikely. And minutes of the Fed’s late January meeting, released this week, has led some economists to push their predictions for the first rate decrease to June or later.
Many of them say inflation still poses the bigger threat and the Fed is on the right track.
“I think they’re right to be patient,” says Barclays economist Marc Giannoni.
What is the current Fed interest rate?
From March 2022 to July 2023, the Fed lifted its key short-term interest rate from near zero to a 22-year high of 5.25% to 5.5% to help wrestle down inflation, which already was slowing as pandemic-related supply chain snarls resolved. Since then, the central bank has held the rate steady.
A drop in the benchmark rate would lower borrowing costs for mortgages, credit cards, cars and other consumer and business loans, stimulating the economy. The prospect of lower rates already has propelled the stock market to record highs.
But after its two-day meeting last month, Powell told reporters that, before slicing the rate, officials want to gain more confidence that inflation “is on a sustainable path down to 2%.” According to the minutes, most policymakers worried about the risk of acting too quickly to chop rates and reigniting inflation. Only “a couple” of officials pointed to the hazards of keeping rates high for too long and causing the economy to weaken significantly or slip into recession.
Is inflation really high right now?
Several reports since the Fed meeting seemingly have vindicated the Fed’s cautious approach. A “core” inflation measure that strips out volatile food and energy items increased a hefty 0.4% in January, keeping the annual rise at 3.9%, according to the consumer price index.
Is the US economy strong right now?
Last month, meanwhile, U.S. employers added a booming 353,000 jobs and average annual wage growth – which feeds into inflation – jumped to 4.5% from 4.3%.
The economy also grew at a sturdy 3.3% annual rate in the last three months of 2023 and a solid 2.5% for the entire year.
The takeaway: The economy is not only on solid footing but could drive inflation higher again as consumers continue to spend their rapidly rising paychecks.
Some forecasters have a different view.
Is rent going down?
Granted, inflation flared in January but that’s just one month and it was mostly due to persistent increases in rent and other housing costs, Zandi says. Rent hikes are expected to ease in the coming months as falling rates for new leases ripple to existing leases.
Also, a different inflation measure that the Fed watches more closely – called the personal consumption expenditures price index – was at 2.6% in December and the Fed’s preferred core reading was at 2.9%, not far from the 2% target.
And if increases in core personal consumption expenditures price index prices over the past six months are annualized, inflation is already at 1.9%, Zandi notes.
By that gauge, “You’ve achieved your objective,” he says.
Are layoffs on the rise?
Meanwhile, he says, the economy isn’t as robust as it appears. Although job gains have been vigorous, the rate of hiring by employers in November hit the lowest level since 2014, excluding the pandemic recession. In other words, net job gains have been strong because employers have been loath to lay off workers following severe pandemic-related labor shortages (aside from high-profile layoffs by companies such as Amazon, Google and Microsoft).
And although the nation’s gross domestic product grew smartly last year, an alternative measure of economic output that some analysts say is more accurate – gross domestic income – has increased feebly.
Zandi, in turn, argues the risk of tipping the economy into recession is now greater than…
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