The U.S. Federal Reserve is widely expected to raise interest rates by at least a 25 basis points next week. And if inflation stays high, the Fed is “prepared to raise by more than that” in the coming months, Chair Jerome Powell said last week.
That would be a mistake. After next week’s hike, the Fed should hit pause for at least the next several months and possibly through the summer — even though the war in Ukraine will no doubt make inflation worse in the U.S.
It’s unclear how bad the conflict will get, the effect it will have on the region and whether it will lead to a global recession this year. The probability of that last is less than the most extreme predictions, but is nonetheless real.
A more aggressive Fed might use a recession as an opportunity to rapidly bring down inflation by sticking to its rate-hike schedule. That is risky policy, and one that Powell seems disinclined to take. If a recession hit, it’s likely that the Fed would simply have to reverse any rate hikes it had made in the preceding months.
A see-saw pattern in rates would weaken the overall impact of the Fed’s policy. Consider, for example, the plight of a homebuilder who cuts production next summer in response to rising rates. She is not likely to increase production immediately if rates fall in December; she’d want to wait for a signal that rates will remain low for a while. From the Fed’s perspective, it would be more effective to leave rates alone, encouraging her to keep production high for the next several months.
