Fed Hikes Rates Again, But Could This Eventually Cause A Recession?

It’s official, the Federal Reserve just hiked its benchmark interest rate another 0.75 percentage points. (If you want to sound in the know, call it 75 basis points, as 100 basis points is 1%—something for your next cocktail party if you can afford the fuel costs to get there.)

This was already expected, which is why you aren’t seeing the stock markets suddenly sink in response. Here’s the Fed’s rationale:

Recent indicators of spending and production have softened. Nonetheless, job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures. Russia’s war against Ukraine is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity. The Committee is highly attentive to inflation risks.

In other words, the institution thinks that inflation will continue high for now, possibly slowing, or maybe even rise. That means personal economics for most people in the country will remain tight.

Could all this cause a recession?

Maybe, if we’re not already in one because it takes time for the umpires—the people at the non-profit National Board of Economic Research—to call that there has been one.

The Fed is in an unenviable position. The agency is supposed to simultaneously control inflation and unemployment. The reason to keep inflation under check is because that can help lead to recession, which is the economic equivalent of running a marathon and finding that you’ve run out of fuel, easily accessible oxygen, and physical strength when you hit the wall.

A recession is similar. There’s supposed to be a theoretical optimum level for the economy to work at. That level is constantly changing and it’s pretty much impossible to define. But the concept is that when the economy works even harder, it burns through capital, paying customers, raw materials, people, and other resources and loses steam. It hits the wall and then can’t continue even at the level it had been before tipping into overdrive.

The Fed has to slow things, but it has few tools to do so. Increasing the baseline rate, which is the target interest rate it wants to see banks lend to one another overnight, pushes other interest rates around. Financing gets more expensive and therefore many companies and people start to spend less. With less demand, business overall slows and the economy recoups.

But during the process, unemployment is likely to go up. Prices have increased sharply and even though some, like energy prices, for example, have started to come down, many won’t. Wages face heavy pressure to keep from rising and most Americans take it on the chin. And the Fed is going to put up with that, because it doesn’t have a lot of other choices.

If you thought people around you were showing signs of economic anxiety, don’t expect that to disappear. Things aren’t likely to go back to normal, whatever that means these days, in the next few weeks or probably months. Maybe longer.

Even though the Fed has ratcheted up interest to slow the economy, it could need to go much further. There are multiple theories of what central banks should do, but eventually the choice may be to cause more pain to slow the train. Of course, the pain goes most to those who have the fewest resources to deal with it, which is a majority of the population.