The Fed Should Be Willing to Cause a Recession

Recent news of unexpectedly high inflation — prices rose by 8.3% in the year to August — made the Federal Reserve’s task this week a little easier. It affirmed investors’ belief that monetary tightening still has a way to go, and that the central bank will most likely raise its policy rate by another 75 basis points on Wednesday. The more difficult question is what comes after that.

This week’s expected increase would leave the target range for short-term rates at between 3% and 3.25%. That’s still substantially negative in real terms, even allowing for the fact that core inflation of 6.3% is lower than the headline rate. Although the Fed is reining back its stimulus, monetary policy is not yet pressing strongly down on demand. Such gradual tightening might be prudent — but only if the central bank makes clear that it’s ready to go further as necessary and will do whatever it takes to get inflation back on track.

Up to now, and despite efforts to set matters straight, there’s been some ambiguity about this. In particular, Fed officials led by Chair Jerome Powell have said they hope to stifle inflation without pushing the economy into recession. A worthy goal, to be sure, and not impossible — but if it’s achieved, it will have been more through luck than skill. Getting high inflation under control almost always involves a temporary contraction of output together with higher unemployment. If the Fed is suspected of flinching at this possibility, its task will be harder. And in the end, output and employment would have to fall more.