ses firms to increase prices, making high inflation self-fulfilling. Uncertainty about the future price level also discourages firms from investing, thereby hindering productivity. Wages may rise, but they won’t keep up with inflation.
Failing to attack the problem may therefore generate an even worse recession than the country currently faces. Such a negligent Fed would lose credibility and need to raise rates even higher to get inflation back down later on. What the Fed is doing now—raising rates by 0.75 percentage points at a time, eventually to reach somewhere around 4 or 5 percent—is a superior alternative. It is administering a mega-dose of antibiotics to kill an infection rather than letting the infection run rampant before cutting off the patient’s leg.
Suppose the Fed didn’t continue raising rates. It would effectively be admitting that it can’t achieve its congressionally mandated mission of low unemployment and stable inflation. In such a world, why would the Fed even bother with monetary policy? A credible and effective Fed is a very powerful tool. But a Fed that won’t raise rates when the economy is overheating is a central bank that can’t cut rates when it is in a recession. And if it gives up on inflation, it also gives up on full employment. Its power depends on its credibility to make hard choices. Some observers have become so accustomed to policymakers doing all they can to boost demand that they’ve forgotten there is no free lunch. The Fed is independent and powerful so that it can make the hard choices nobody wants but everybody needs.
Recessions have happened for many reasons. Sometimes they are unavoidable, owing to big external shocks. Other times they stem from over-investment and the natural business cycle. But the most frustrating recessions come from policy mistakes. A soft landing is still a possibility, if a seemingly remote one. And a Fed-caused recession will not be popular—even if is necessary. The hope is that such a contraction will be less painful than the alternative.
But Powell’s institution does deserve some blame: a series of policy errors, including loose monetary policy well into the pandemic, helped put the economy in its current position. If the looming threat of recession and the current market turbulence feels like the result of a policy mistake, that’s because it is. But the mistake isn’t raising rates now. It was failing to do so earlier.
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