A new research paper about Anti-Inflation strategy has stated that the Federal Reserve cannot defeat inflation without causing a recession. The paper, produced by a group of leading economists, states that this “immaculate disinflation” has never happened before.
The research reviewed 16 episodes since 1950 when a central bank like the Fed raised the cost of borrowing to fight inflation, in the United States, Canada, Germany, and the United Kingdom. In each case, a recession resulted. The paper coincides with a growing awareness in financial markets and among economists that the Fed’s Anti-Inflation strategy will likely have to boost interest rates even higher than previously estimated. Over the past year, the Fed has raised its key short-term rate eight times.
The Federal Reserve typically responds to high inflation by raising interest rates, often aggressively, to cool the economy and slow price increases. However, sometimes inflation pressures still prove persistent and require ever-higher rates to tame. The result — steadily more expensive loans — can force companies to cancel new ventures and cut jobs and consumers to reduce spending, leading to a recipe for a recession.
Inflation has been surging for the past two years, and the Fed’s response has been to raise interest rates, but the current research paper concludes that this will lead to a recession. The researchers reviewed 16 episodes since 1950 when a central bank like the Fed raised the cost of borrowing to fight inflation, in the United States, Canada, Germany, and the United Kingdom. In each case, a recession resulted. “There is no post-1950 precedent for a sizable… disinflation that does not entail substantial economic sacrifice or recession,” the paper concluded.
The paper was written by a group of economists, including Stephen Cecchetti, a professor at Brandeis University and a former research director at the Federal Reserve Bank of New York; Michael Feroli, chief U.S. economist at JPMorgan and a former Fed staffer; Peter Hooper, vice chair of research at Deutsche Bank, and Frederic Mishkin, a former Federal Reserve governor.
The latest evidence of price acceleration makes it more likely that the Fed will need to do more to defeat high inflation. Yet Philip Jefferson, a member of the Fed’s Board of Governors, offered remarks Friday at the monetary policy conference that suggested that a recession may not be inevitable, a view that Fed Chair Jerome Powell has also expressed. Jefferson downplayed the role of past episodes of inflation, noting that the pandemic so disrupted the economy that historical patterns are less reliable as a guide this time.
“History is useful, but it can only tell us so much, particularly in situations without historical precedent,” Jefferson said. “The current situation is different from past episodes in at least four ways.”
Those differences, he said, are the “unprecedented” disruption to supply chains since the pandemic; the decline in the number of people working or looking for work; the fact that the Fed has more credibility as an inflation-fighter than in the 1970s; and the fact that the Fed has moved forcefully to fight inflation with eight rate hikes in the past year.
Loretta Mester, president of the Federal Reserve Bank of Cleveland, accepted the paper’s findings, saying they suggest that inflation could be more persistent than currently anticipated. She sees the risks to the inflation forecast as tilted to the upside and the costs of continued high inflation as being significant.
Susan Collins, president of the Boston Fed, held out hope that a recession could be avoided even as the Fed seeks to conquer inflation with higher rates. Collins said she’s optimistic there is a path to restoring price stability without a significant downturn. She added, though, that she’s well-aware of the many risks and uncertainties now surrounding the economy.
