Is the recession the only cure for inflation in the United States?

The specter of a recession looms over the United States, an evil that may prove unavoidable if the world’s largest economy is to be saved from inflation. This assumption is gaining momentum following the central bank’s historic decision to raise interest rates sharply.

“The odds of a recession in 2023 are increasing because of the need to control inflation,” Joseph Gagnon, an economist at the Peterson Institute for International Economics (PIIE) and a former Fed economist, said in a note.

The US economy has already slowed, with GDP falling 1.5% in the first quarter. The start of the second quarter seems to show that the slowdown in certain sectors such as manufacturing, real estate and retail is continuing.

Big Evils Call for Big Cures: In the face of ever-rising prices, the economy must slow down as American consumer demand remains strong and supply insufficient.

“Purchasing power has to match supply,” Steve Englander, head of US macroeconomics at Standard Chartered and a former Federal Reserve economist, told AFP.

And that is precisely the job of the Fed. By raising its key interest rates, it encourages commercial banks, private individuals and companies, who are therefore less willing to spend, to offer more expensive loans.

– Soft landing pulls away –

As a result, after inflation broke a new record in 40 years (8.5% over a year) in May, the institution on Wednesday made the largest hike in its key interest rates since 1994, raising them by three-quarters of a percentage point to bring them in to bring the range from 1.50 to 1.75%.

This third increase will be followed by further strong increases by the end of the year.

“To be clear, we’re not trying to create a recession,” said Fed Chair Jerome Powell. “We’re trying to get inflation back to 2% and keep the job market strong.”

The Fed is now expecting 5.2% inflation this year, down from 4.3% at its March meeting. At the same time, it is forecasting growth of just 1.7% after 2.8% previously.

“The risk of a recession is increasing, and strongly,” said Steve Englander, who believes this scenario is avoidable.

However, the “soft landing” promised by Jerome Powell a few weeks ago now seems very difficult to achieve.

“The prospects for a soft landing are looking increasingly unlikely, and we think a recession next year is more likely than not,” warns Jay Bryson, economist at Wells Fargo.

Indeed, he explains, “inflation is setting in (…) and eroding real income, which is likely to weigh on consumer spending growth in the coming quarters”.

In addition, the Fed’s sharp rate hikes will “ultimately weigh on rate-sensitive spending,” ie, purchases on credit. Many of these are located in the United States.

– A “Goldilocks” Economy –

But the venerable and powerful Federal Reserve is willing to take that risk to avert high inflation that “will persist for many years to come,” notes Kathy Bostjancic, chief economist at Oxford Economics.

Ideally, America’s economy should follow a path known as “Goldilocks,” named after the children’s story, she tells AFP. In other words, an economy that chills just right, at the right temperature, like Little Bear’s soup bowl that devours the little girl in the story.

The consumption frenzy that the country has been experiencing for almost two years, thanks in particular to the government’s generous financial aid, is encountering ailing production due to the global supply difficulties that have persisted since the beginning of the Covid-19 crisis.

As a result, prices shot up.

And the war in Ukraine added an extra layer. Rising oil prices in a country where cars are often essential and fuel-hungry are putting a strain on households, as are rising food prices.

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