With inflation at a four-decade high and the Federal Reserve increasing interest rates despite falling growth expectations for the U.S. economy, a recession is now all but inevitable, according to Bill Dudley, the former president of the Federal Reserve Bank of New York.
Dudley admonished Federal Reserve Chair Jerome Powell in a Bloomberg op-ed published Tuesday, arguing he was too slow to act to control rising inflation over the past year. Now, Dudley says, the Fed chair won’t be able to achieve a “soft landing” for the U.S. economy — curbing inflation without creating a recession.
“The Fed’s application of its framework has left it behind the curve in controlling inflation. This, in turn, has made a hard landing virtually inevitable,” Dudley wrote.
The Federal Reserve has two main goals collectively known as its “dual mandate”: to ensure price stability and maintain maximum sustainable employment.
Throughout the pandemic, Powell used ultra-accommodative monetary policy to help stabilize the American economy. That came in the form of near-zero interest rates and billions of dollars in quantitative easing — central bank purchases of financial assets in order to increase the money supply and encourage lending and investment.
The Fed’s actions have helped the unemployment rate fall to just 3.8% as the U.S. economy experienced one of the fastest recoveries from a recession in history, but there was a catch — inflation.
While the Fed was able to help millions of Americans remain employed throughout the pandemic, it also stoked economic “overheating,” according to Dudley. As a result, inflation has become a serious issue, eating away at the paychecks of Americans despite historic wage increases.
“Powell blames bad luck — surprises such as snarled supply chains that officials could not have anticipated,” Dudley wrote. “To some extent he might be right, but the Fed nonetheless bears responsibility for being so slow to recognize the inflation risks and begin to tighten policy.”
Dudley goes on to detail three periods in the past where the Fed was able to raise interest rates without creating a recession: 1965, 1984, and 1994. However, according to the former New York Fed president, the current economic situation is very different from these previous periods, as the U.S. economy has a lower unemployment rate and a substantially higher inflation rate.
That means that this time, the Fed will be faced with a difficult decision, Dudley says.
“To create sufficient economic slack to restrain inflation, the Fed will have to tighten enough to push the unemployment rate higher,” he wrote.
Dudley points to the Sahm rule, invented by economist Claudia Sahm, which indicates a recession is inevitable when the 3-month moving average of the unemployment rate increases by half a percent or more.
Simply put, if the Fed wants to control inflation, Dudley believes it will also be forced to increase unemployment thereby sparking a recession.