The media and market chatter is that the Federal Reserve finally took out the anti-inflation bazooka with a 75-point rate increase on Wednesday, and there’s no doubt Chairman
sounded hawkish rhetorical notes. But the overall message still looked more like a central bank slouching toward inflation reality, but not yet convinced it has to do all that much to get prices under control.
The 75-point increase at a single meeting was supposed to signal shock and awe, and it was the Fed’s first move of that magnitude since 1994. Mr. Powell also said an increase of between 50 and 75 basis points is likely at its next meeting in July.
But if you look at the Fed’s median forecast, the fed-funds interest rate is expected to rise only to 3.4% by the end of this year. That means increases will taper off through the rest of the year, and the Fed predicts a peak of only 3.8% in 2023. The Fed is front-loading its rate increases, but it’s still not anticipating that it has to go all that high to beat inflation.
No wonder bond yields retreated Wednesday even as equities rallied. Markets read the Fed’s median forecast on Wednesday as less hawkish than Monday’s Fed leak to the press about the likely 75-point increase.
Will this really be enough to get consumer-price inflation down from 8.6% today to the Fed’s target of 2%? Perhaps, but at this rate it’s going to take a while. The Fed forecast for its preferred measure of inflation (the personal-consumption expenditure or PCE index) at the end of this year is now 5.2%. But PCE inflation has been more than 6% at an annual rate in recent months, which means inflation would have to fall sharply over the next six months to hit 5.2% for the year. The Fed’s forecast that inflation will hit 2.6% in 2023 seems even more unlikely—unless there’s a recession.
The central bankers certainly are optimistic—which makes us wonder if they still think, down in the bones of their economic models, that inflation really is “transitory.” They still seem to believe the main inflationary fault lies with Covid, supply chains and the Ukraine war, not with their monetary policy, so the Fed doesn’t have to do all that much monetary tightening.
The Fed’s median forecast is also remarkably sunny for the economy, despite rate increases. The forecast has the jobless rate rising to only 3.9% in 2023 from 3.6% today, and GDP growth falling no lower than 1.7%.
We hope Mr. Powell is right that the economy is “very strong” and the consumer is in shape to power through higher rates. But the economy shrank 1.4% in the first quarter, and the Atlanta Fed’s GDPNow tracker on Wednesday cut its growth forecast in the second quarter to zero. Consumers whacked by inflation and gas prices are reining in their spending, as retail sales fell in May.
Mr. Powell is sounding the right note when he says price stability is the bedrock of economic growth. But regaining the Fed’s inflation-fighting credibility after two years of mistakes will take more than one 75-basis-point increase, and Americans will believe it only when they see it in falling prices.
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Appeared in the June 16, 2022, print edition.