More Rate Hikes and a Soft Landing

Many are calling for the Fed to slow its rate hikes in the coming months, yet Jerome Powell appears to be pushing for more. On Thursday, he did not deny market expectations of a 75 basis point increase.

He also suggests he would consider a modest increase in unemployment as a "soft landing," an approach which hasn't worked well before.

Economic Growth

Economic growth promotes a country's prosperity by increasing its total production of goods and services. This expansion is caused by technological progress and capital accumulation. A country can also increase production capacity by reallocating resources to other uses, such as increasing labor force participation or decreasing working hours.

Economic growth is driven by several factors, but two of the most critical ones are population and labor productivity. A more productive labor force can increase output per hour worked, contributing to increases in GDP and income for an entire economy.

It is essential to remember that economic growth can only be sustained if the political settlement allows more open, participatory economic activity. Failing to do so, growth may stagnate or even stop altogether.

This is especially true if the political settlement does not enable the development of economic policies that could promote more productive growth. For instance, a government may stimulate growth with expansive fiscal policy (by spending more or cutting taxes), leading to deficit spending and higher debt levels in the long run.

However, a more productive political settlement can enable growth without creating excessive debt or deficit spending. This is because the government can use tax revenues to fund public services like education and healthcare.

The United States boasts an abundance of natural resources, labor and capital equipment - all critical elements in economic growth. Unfortunately, the country has experienced a slowdown in productivity growth for two decades due to several economic policy errors.

To increase productivity in the United States, it is necessary to enhance its labor market and invest in technology. Doing so will enable it to create more and better products, services, and jobs.

However, it remains uncertain if this goal can be reached in the short term. In 2023, economists predict the economy to slow and a recession could well occur.

Despite all these difficulties, the economy still appears healthy. According to the November Survey of Professional Forecasters, real GDP growth is forecast at 1% for the fourth quarter this year - well below its trend growth rate of 2%. While this number falls well short of inflationary pressures on wages and salaries, it nevertheless represents a positive sign.

Inflation

The United States is on track for higher inflation levels than ever before, and the Fed may need to keep raising interest rates in order to bring prices down. But if inflation goes too far, it will erode consumers' purchasing power and stifle demand.

The government tracks inflation through various price indices, such as the Consumer Price Index (CPI). This data is used to adjust income eligibility for government assistance and other programs and calculate cost-of-living adjustments for consumers.

Prices fluctuate over time, and each has an impact on the economy. Some adjust rapidly, such as those based on traded commodities; others take longer to adjust, such as wages set by contracts.

Inflation is a key concern among economists, and the Federal Reserve (Fed) is responsible for keeping prices at an level that encourages economic growth. In the United States, they target an annual increase in prices at 2 percent; however, they may allow inflation to exceed this threshold temporarily in order to make up for periods when prices were lower.

It is essential to recognize there are various types of inflation. These include "demand-pull" and "cost-push" inflation.

"Demand-pull inflation" refers to price increases caused by economic policies that cause consumption levels to exceed their normal productive capacity. This type of inflation usually has an immediate impact on retail prices.

But inflation can also be caused by supply disruptions, such as those in the energy or food markets. This type of inflation usually comes in small increments and is less severe than "cost-push" inflation.

In order to reduce inflation and get back on track toward its target of 2 percent, the Fed may need to raise interest rates at a faster pace. Unfortunately, this pace is incompatible with the current pace of economic growth; some sectors of the economy could experience further weakness if rates remain at this higher level.

Unemployment Rate

Recently, the Fed has increased interest rates in an effort to curb price rises and slow economic expansion. Unfortunately, these moves are incompatible with a more sustainable labor market and could potentially push America into recession.

The unemployment rate is the most commonly used indicator of economic health, but other indicators can provide more insightful information on job market stability. For instance, the employment-to-population ratio provides a more precise indication of employment conditions than its more familiar counterpart since it does not depend on voluntary labor force participation.

Another essential indicator of labor market health is slack in the labor force. This refers to people who are unemployed but would like to work. Slack tends to be higher among groups more susceptible to underemployment, such as women and young people.

Despite the weakness in the labor market, the unemployment rate remains low. This suggests that the economy remains strong enough to withstand further rate increases in the future.

That means the central bank does not face any major obstacles in its quest to stabilize prices for goods and services. Therefore, it may be able to create a "soft landing" for the economy and bring inflation back down without overheating it.

One important element of the Fed's strategy is to slow the rise in prices, encouraging more employers to raise wages and boost demand for goods - which could also assist stock prices.

The Fed has sought to achieve this by raising interest rates and setting limits on how much companies can borrow. Though no formal end has been set to these increases yet, their latest actions appear to be leading in that direction.

Trading markets anticipate the Federal Reserve will raise interest rates again in March or May due to strong jobs data this month. This suggests they plan to continue their rate-hiking cycle, pushing unemployment toward 4% - the minimum level needed to slow inflation and sustain a robust economy.

The Fed’s Track Record

Since 1913, the Federal Reserve has been guided by a dual mandate: keep prices stable and achieve full employment. To this end, an annual inflation target of 2 percent has been established as its benchmark rate.

Inflation is a problem for the economy as it increases living costs and causes consumers to spend less. This results in a loss of wealth for both businesses and individuals alike. That is why the Federal Reserve has been successful at reducing inflation through rate hikes while simultaneously striving to keep unemployment below 4 percent.

However, maintaining these goals in the current economic climate can be challenging due to unpredictable events like wars or pandemics that could disrupt activity. Furthermore, the Fed has a mandate for overseeing financial system stability by monitoring banks' solvency and conducting stress tests on them.

These factors have caused the Fed to advocate for further rate hikes in an effort to control inflation and slow growth. But this strategy could backfire if they don't succeed, the economy could enter recession.

The difficulty with this strategy is that the economy takes time to adjust to changes in monetary policy, making it difficult for the Fed to know when they've achieved their target. This holds especially true when trying to achieve a soft landing - which requires gradual adjustments in order to prevent an economic overheat and subsequent recession.

Many economists worry the Fed could send the economy into a recession if it continues to raise rates in the short term. This would force consumers and businesses to cut spending, slowing growth and increasing unemployment rates.

Though the Fed has occasionally managed to achieve a soft landing in the past, this was usually due to luck and favorable circumstances such as growth-promoting fiscal policy in the 1980s or disinflationary technology investment in the 1990s.

This time around, however, the Fed faces a unique set of circumstances. They must contend with an unfavorable economic climate--including higher gas prices and the potential for recession--as well as trying to control the economy from a central bank--a task much more intricate than before they took over.