After a new analysis of Fed policy since World War Two, a top economic adviser and senior in the Obama White House stated that the Federal Reserve’s effort to startle the economy into lower inflation is in its initial stages, making it difficult for the U.S. central bank to mitigate overdoing it with higher-than-necessary interest rates.
Christina Romer, an economist at the University of California, Berkeley and the former chair of the White House’s Council of Economic Advisers (CEA) from 2009 to 2010, spoke to a national gathering of economists late on Saturday. She noted that the Fed has increased its target policy rate by more than 4 percentage points in the past year, and the economy is now entering the window where the impacts might start to be felt.
Romer said in a keynote talk at the annual meeting of the American Economic Association in New Orleans that because of the lags entailed, policymakers will have to make a very tough choice regarding when to stop raising interest rates or change course.
If policymakers want to bring inflation down without inflicting more suffering than necessary, they will need to back off before the issue is fully resolved, she said.
In an effort to avoid making a mistake, Fed officials have dialled back the rate at which borrowing prices are rising.
They understand how difficult it will be to determine how higher to raise rates and how much longer to keep them up.
The minutes of the most previous Fed policy meeting in December revealed central bankers fumbling with the dangers, and experts believe that a U.S. recession is highly likely to occur in the upcoming year as a result of rate rises.
Romer, the outgoing president of the AEA, argued as CEA head for a significantly stronger budgetary response to the 2007–2009 recession than was allowed.
Romer is an expert on the origins and recovery from the Great Depression of the 1930s.
She worked alongside her husband, Berkeley economist David Romer, to examine U.S. central bank policies by examining Fed meeting minutes and transcripts going back to the 1940s.
They found ten instances where the Fed made deliberate attempts to alter the course of economic growth, with the exception of one, all in an effort to reduce inflation that it believed to be excessively high.
They relied solely on minutes in more recent years because transcripts are only accessible until 2016 and came to the conclusion that the present tightening cycle counts as the eleventh “shock” to monetary policy.
Those occurrences stand in contrast to previous Fed rate choices intended to follow the business cycle or react to exogenous economic events, including the downfall of the housing sector and the start of the recession in 2007.
She said that isolating the shocks gives a clearer picture of how and when Fed rate increases affect economic output and employment.
She discovered that as interest rates increase, the overall output starts to decline roughly six months from the onset of the policy shock and was 4.5% lower after nine quarters than it would have been otherwise. After approximately five months, the unemployment rate begins to increase. After 27 months, it increases by an aggregate of 1.6 percentage points, and after five years, the effect is less pronounced.
The Fed started raising rates in March of last year, but in June it quickened the pace to a level similar to the rapid tightening employed by former Fed Chair Paul Volcker in the late 1970s and early 1980s.
The policy rate of the central bank is currently between 4.25% to 4.50%, and officials are largely anticipated to increase it yet another quarter of a startling percentage point at their meeting on January 31–February 1 in order to raise it over 5% in the coming months.
