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Fed Will Need ‘Significantly’ More Rate Hikes to Combat Inflation, According to New White Paper
February 24, 2023
The Federal Reserve will most likely not be able to bring down inflation without having to substantially raise interest rates and trigger a recession, according to a new research paper.
The paper, presented by the University of Chicago Booth School of Business and co-authored by former Fed Governor Frederic Mishkin, examines the history of central banks’ efforts to fight inflation.
While current Fed officials seem optimistic that they can engineer a “soft landing,” meaning bringing inflation back down to the Fed’s 2% target without triggering a recession, the paper’s authors argue that is unlikely to be the case.
The paper’s authors found “no instance” of a central bank inducing disinflation without a recession. While the Fed has already raised rates at the fastest pace in modern history in its efforts to combat inflation that is surging at the fastest pace in more than 40 years, the paper argues they still have a ways to go.
“Simulations of our baseline model suggest that the Fed will need to tighten policy significantly further to achieve its inflation objective by the end of 2025,” the researchers said.
“Even assuming stable inflation expectations, our analysis casts doubt on the ability of the Fed to engineer a soft landing in which inflation returns to the 2 percent target by the end of 2025 without a mild recession,” they added.
The paper argues against raising the Fed’s 2% target, as some economists have proposed, though they did recommend the Fed abandon its “average inflation targeting” policy, which allowed inflation to run hotter than normal in favor of allowing the labor market to recover after the pandemic. Instead, the researchers say the Fed should go back to its preemptive mode where it started raising rates whenever unemployment fell sharply.
