Rising prices may turn the Fed into a reluctant villain

The sympathetic central banker has no place in a world of high inflation. Consumer prices in the United States increased by 8.6% year-on-year in May, a figure that exceeded forecasts. Federal Reserve Chairman Jay Powell has no choice but to increase interest rate hikes, inflicting more damage on people already struggling with high food and gasoline prices. Doing so is rational in the long run, and wicked in the short run.

Friday’s inflation figures shattered the theory, supported by economists polled by Reuters, that prices had stabilized in May. Rather, they rose to their highest level since 1981.

Food costs rose even more than the headline figure, rising nearly 12% year-over-year, the Labor Department reported. Gasoline, the lifeblood of the US economy, is up nearly 49% from a year ago.

Powell’s only option is to hurt Americans more. Last month, he essentially ruled out rate hikes of more than 0.5 percentage point at a time. With inflation rising rather than receding, he may have to consider bigger hikes—say, three-quarters of a percentage point—that will make credit card balances and mortgages more expensive, and possibly send the economy into a tailspin. recession.

Consumers were already in trouble. An index that measures the volume of mortgage applications has fallen to its lowest level in 22 years due to the rise in interest rates, the Mortgage Bankers Association reported on Wednesday. Households are spending $341 more a month for the same goods and services than they were a year ago, according to Moody’s Analytics.

Paul Volcker’s example might give Powell some consolation. Head of the central bank from 1979 to 1987, Volcker faced inflation that had reached 13.5% the year after his appointment and doubled interest rates to nearly 20% in just six months. Two consecutive recessions occurred; the unemployment rate reached nearly 11% in 1982. Some legislators proposed removing Volcker from office. But a year later, inflation dropped to 3.2% and the economy boomed from then on.

Powell probably won’t have to make such a big move on rates, but raising rates in larger increments will continue to hurt average Americans. And it is not clear how much influence monetary policy will have, given that the increase in food and gasoline prices is largely due to the war in Ukraine. As with Volcker, the story may see Powell as a hero, but in the meantime he’s on his way to making plenty of enemies.