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Why experts say it is difficult to lower inflation without a recession

Federal Reserve Building Fed
Posted at 3:43 PM, Jul 11, 2022
and last updated 2022-07-11 15:51:58-04

Another potential interest rate hike could be decided this month as the U.S. government tries to combat the worst inflation in nearly 40 years.

It is a difficult task as tipping the scales of the economy will slow inflation but it could also lead to a recession, where the economy contracts and jobs are oftentimes lost.

“I expect, more likely than not, we’ll have a recession in 2023. That means higher unemployment,” said David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution, a nonpartisan research group established more than 100 years ago.

Wessel says to lower the steep rate of inflation, the Federal Reserve must shrink the economy through higher interest rates that make borrowing money more expensive and deter people from buying.

“What [the Federal Reserve] is basically saying is— we’re going to have to have some short-term pain in order to avoid much worse pain down the road,” said Wessel. “And that’s really easy for them to say because they all have jobs, but it’s really unpleasant if you’re the person who has to bear the pain.”

For more than a decade, Wessel says a lot of things were happening prior to the pandemic that favored lower prices: increased globalization, favorable trade deals, and more workers coming into the world economy, but after the pandemic, that changed. The massive amounts of stimulus money pumped into the economy to buoy families through the pandemic among them.

“We might be at an inflection point where a lot of the forces in the global economy were winds blowing to push prices down and now some of those winds have shifted, and when we get through this ugly period, it might be that the forces of the world economy are pushing prices up,” said Wessel.

The difficult part about combatting those forces in the short-term, Wessel says, is the Federal Reserve cannot predict how much its policies will affect the economy. It can only go off data from the past.

It is why the Fed has implemented incremental interest rate hikes, so it can evaluate the impact and then decide on next steps.

In the longer term, Wessel says the Federal Reserve is looking at solutions that would sustain a strengthened economy such as promoting more competition to knock down prices, empowering unions to pump up wages, and growing productivity among the U.S. workforce.

“If we make these investments, we have reason to believe we can have faster productivity growth and that will allow us to have more goods and services without paying more for them and that would be the happy ending,” said Wessel.