It’s too soon to say whether the Federal Reserve’s efforts to reduce inflation will lead to a recession, but continuing interest rate hikes increase the chances.
This is the sentiment of the National Retail Federation’s Chief Economist, Jack Kleinhenz.
He explained: “This year starts with the possibility of easing inflation but also uncertainty. There is no easy fix for inflation, and the Fed’s job of trying to bring down rising prices without damaging the labor market or the rest of the economy is not enviable.”
Adding: “It isn’t impossible to sidestep a recession, but when the economy slows it becomes very fragile and the risk rises significantly. If a recession is in the cards, it will likely be rising interest rates that set it off.”
Kleinhenz’s remarks came in the January issue of NRF’s Monthly Economic Review, which noted that the Fed increased interest rates another one-half percentage point in December even though year-over-year inflation as measured by the Consumer Price Index fell to 7.1% in November.
Inflation was down from 7.7% in October for the fifth consecutive monthly decline after a peak of 9.1% in June.
The interest rate hike was smaller than recent three-quarter-point increases but took rates to their highest level in 15 years and showed “the battle against inflation is still at hand,” the report said.
Even though inflation has fallen, “it remains in the pipeline and is not going away,” the report said. “Americans are still out spending” – fueled by growing jobs and wages, built-up savings and careful use of credit – and “healthy” 2022 holiday sales showed “while consumers don’t like higher prices, they are able and willing to pay them.”
Final holiday spending data won’t be available until January 18, but November sales as calculated by NRF increased 5.6% year over year, putting the season on track to meet NRF’s forecast of 6% to 8% growth over 2021. And after a 2.6% year-over-year increase in the third quarter, gross domestic product was growing at a 2.7% rate in late December, according to the Federal Reserve Bank of Atlanta’s GDPNow real-time tracker.
While the Fed’s interest rate hikes are intended to slow the economy and bring inflation under control, it can take six months or more for monetary policy to have an impact on GDP and 18 months for inflation, the report said.
That means policymakers “act knowing they will not see the impact for months and that their action comes at the risk of inducing a recession.
“There are downside risks both in doing too much and too little, and the Fed is well aware that the balance is delicate,” Kleinhenz concluded.