Fed’s “golden path” to lower inflation may have some bumps

The “golden path” that some officials of the Federal Reserve considered to lead to lower inflation without high unemployment may prove difficult to find, like the pot of gold at the end of the rainbow, in a world of fast-moving markets facing a new war in Middle East.

At this week’s annual meeting of the National Association for Business Economics (NABE) in Dallas, policymakers at U.S. central banks said they continue to believe they can find a path to reducing inflation to their target of 2%, without a recession being necessary to create enough “slack” in the economy.

However, they and other economists present also warned of risks on the horizon, some of which could slow activity outside the control of the Fedand others that could keep inflation high and force the central bank to contain the economy more than expected.

In both cases, the result would take the Federal Reserve off that “golden path” onto a much more familiar one: An economy that falters as borrowing costs rise and confidence declines.

“I don’t think it’s inevitable” that the unemployment rate will rise significantly for inflation to return to its target, Dallas Fed President Lorie Logan said Monday. “I think there is a possible path, but the most important thing is that we remain focused on restoring price stability, and I think that will require some rebalancing in the labor market.”

Fed Vice President Philip Jefferson, who also spoke at the NABE event on Monday, was satisfied that employment continues to grow, as long as it is “orderly and consistent” with 2% inflation.

“The growth of employment It is positive in itself,” he said. “We just want this process in the labor market to be orderly and consistent with the type of economy that grows over time and is not inflationary.”

Minutes from the Fed’s Sept. 19-20 meeting, due to be released Wednesday at 1800 GMT, could shed light on the risks Fed officials see to the “soft landing” that many believe is in store. The end of the “golden path” is seen, a term coined in July by the president of the Chicago Fed, Austan Goolsbee.

Beyond your control

Since the inflation began to rebound in 2021, those responsible for monetary policy have disagreed on the magnitude of the blow that would need to be dealt to employment to contain the pace of price increases.

Some said recession-level layoffs would be needed; Others argued that the coronavirus pandemic had so skewed labor supply and demand that it could occur without major job losses.

Although this summer the data and events seemed to go in favor of the Federal Reserve’s optimists, with a slowdown in both the pace of price increases and hiring and an influx of workers into the labor market that also helped, the latest Events showed how much is beyond the control of the Federal Reserve.

The US Government published a report on Friday on the employment which showed that employers continued to hire in September at a possibly unsustainable pace, adding 336,000 jobs, roughly triple what is needed for the labor market to stay afloat.

This dealt a blow to the Federal Reserve’s hopes that its aggressive rate hikes since March 2022 had already had a greater impact on labor markets.

At the same time, investors have been pushing up Treasury yields. USA in what amounts to a market-driven tightening of financial conditions, over and above what the central bank itself has instigated.

This will have unpredictable effects, on a potentially global scale, and has caught the attention of Federal Reserve officials, who say it will have to be taken into account when determining monetary policy.

Jefferson, for example, said he is wary of the extent to which high market interest rates will bite as more businesses and households have to refinance loans taken out when rates were low.

War

Meanwhile, the outbreak of armed conflict between Palestinian and Israeli militants could disrupt global energy markets in ways that could delay, if not reverse, progress in containing inflation.

So far, the immediate consequences of the violence in the markets have been few. On Tuesday, crude oil prices rose about 4% from Friday, ahead of surprise attacks by the Palestinian Islamist group Hamas against Israel.

In a sign of the mixed signals the Federal Reserve must process, U.S. Treasury yields fell, as is often the case in times of international tension, as they continue to be considered a risk-free investment.

But the picture has become dimmer at best, according to Christina Romer, a professor at the University of California at Berkeley and former head of the White House Council of Economic Advisers. Her analysis of past periods of inflation and disinflation makes her think that the labor market may still need a shakeup for the Federal Reserve to be successful.

The new data from Consumer Price Index (CPI) released Thursday will show whether inflation continued to slow in September or whether progress has stalled. The CPI rose to 3.7% year over year in August, while the measure of inflation used by the Federal Reserve to set its 2% target, the personal consumption expenditures price index, rose to 3.5%.

Romer said that two months ago he agreed with Goolsbee and other optimistic officials at the Federal Reserve in which a history-defying “soft landing” seemed to be unfolding.

However, “the figures that have been published lately have made me nervous and have made me think that it is going to be more difficult than we thought to get down” to 2% inflation, she said on the sidelines of the NABE meeting in Dallas. .

“I think it’s likely that the Federal Reserve will have to take more action,” Romer said. “As nice as it is to see a really strong labor market, when you’re trying to bring inflation down, that’s not favorable.”