Recession fears are on the rise after the Federal Reserve last raised interest rates by 75 basis points (0.75%) at the July meeting of the Federal Open Market Committee. With a month-long hiatus until the next FOMC meeting in September, an economic slowdown already weak in several indicators and a second quarter of GDP contraction, concern is growing that the economy is heading or could already experiencing a recession.
“Investors and economists have wrestled with the idea that the Federal Reserve could cause a recession or, worse, a prolonged recession by a policy mistake (i.e. raising rates too aggressively),” wrote Mark Hackett, head of investment research for Nationwide’s Investment. Management Group, in a recent blog post.
The problem with interest rate hikes lies primarily in their timing – both the Fed’s late response to the rate hike and the speed of this rate hike cycle. If done too aggressively, it could push the economy squarely into a recession. The Fed has acknowledged that a recession is “definitely a possibility”, according to Federal Reserve Chairman Jerome Powell, but the central bank remains focused on controlling inflation, even at the expense of the US economy.
Image sources: Nationwide Blog
Hackett compares the assessment of the impacts of monetary policy to the “crazy in the shower” idea of Nobel laureate in economics Milton Freidman. It’s like taking a shower that’s too cold, adding hot water to make the water hotter, then waiting for the water to adjust, making it even hotter, finally ending in a hot shower. .
“Friedman said monetary policy works with long and variable lags, and any change in monetary policy must be made slowly to gauge the effect on the economy,” Hackett explained.
The aggressive monetary policy the Fed has undertaken, with four consecutive months of interest rate hikes that have a current rate range of 2.25% to 2.5%, has been in direct response to persistently high inflation. Meanwhile, GDP contracted for the second straight quarter and other indicators are also starting to reflect the economic downturn.
“It is important to note that the Fed could raise rates while the US economy is already in recession. This uncertainty or ‘recessionary fog’ can cause investors to wonder whether a coming recession will be imminent, shallow, prolonged, or something else entirely,” Hackett mused.
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