REGIONAL FOCUS: UNITED STATES
Fighting inflation
As the Federal Reserve grapples with persistent high inflation, how will it
manage the risk of recession? flow shares some insights from the US Deutsche Bank Research team
A
t the end of 2021, rising inflation and the unwinding of globalisation, along with the impact of climate change
policies, were the watch areas as the new year beckoned. But, by mid-2022, the impact of the Russia/Ukraine war and a spike in energy prices had wreaked havoc on what was supposed to have been a recovery from Covid-19 among G7 economies. As David Folkerts Landau and Peter Hooper pointed out in their April 2022 World Outlook, “War has broken out in Europe with Russia’s invasion of Ukraine—a development that has pushed energy prices significantly higher and disrupted a number of other key commodity markets and supply chains... Even more importantly for the economy further down the road, the momentum of inflation has continued to build at a surprising pace in the US, Europe and elsewhere, necessitating more aggressive tightening of policy by key central banks.”
This was underlined by the Federal Reserve’s FOMC statement published on 15 June: “Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.” What does this mean for monetary policy?
Central bank intervention Federal Reserve rate hikes demonstrate that the monetary policy stance is adjusting quickly to a new reality of persistently elevated inflation. Deutsche Bank’s US Chief Economist Matthew Luzzetti wrote in his ‘Fed Notes’ report (14 June 2022), “Ideally, these moves will reign in demand more quickly and prevent a further rise in inflation expectations, helping to short circuit this possible adverse feedback loop before it starts.” However, the speed of tightening needed to curb inflation carries with it the risk of tipping the US economy into recession. “A more accelerated Fed hiking cycle ultimately should
Figure 1: Inflation to run well above Fed’s target through 2023 10.0 8.0 6.0 4.0 Forecast 2.0 0.0 2019 2020 Headline PCE Core PCE 2021 2022 Headline CPI 2023 Core CPI Source: BEA, BLS, Haver Analytics, Deutsche Bank 2024 2.0 0.0 2025
Headline CPI: peak in Sep at 9.1%, 8.2% year-end (q4/q4) Core CPI: 6.0% year-end (q4/q4)
10.0 8.0 6.0 4.0
help tame inflation pressures but will make it more difficult to thread the needle between lower inflation and a recession. We continue to anticipate that bringing inflation back down to target will require a meaningful hit to demand and rise in the unemployment rate, the latter of which historically does not happen without a recession,” reflected Luzzetti. However, while acknowledging that the
Fed’s leverage over inflation is primarily via damping growth in aggregate demand – and hence the demand for employment – Luzzetti added that the Fed’s Chair, Jerome Powell, went to some pains to avoid saying a recession might be the required medicine. In his view, the Fed’s Summary of Economic Projections (SEP) skirts “very close to a recession with the unemployment rate rising 0.5 points over the next two years”. While overly optimistic, Luzzetti does see
this as “a step in the right direction and a recognition of what might be needed to maintain the Fed’s credibility as it strives to keep inflation expectations in check”.
Deutsche Bank Research reports referenced • World Outlook 2022–24: Over the Brink (5 April 2022) by David Folkerts-Landau and Peter Hooper, Deutsche Bank Research
• Fed notes. June FOMC recap: A perilous path to price stability (14 June 2022) by Matthew Luzzetti, Peter Hooper, Brett Ryan, Justin Weidner and Amy Yang, Deutsche Bank Research
• US Inflation Outlook: Sizzling spring service inflation spooks central bank (21 June 2022) by Matthew Luzzetti, Suvir Ranjan, Brett Ryan, Justin Weidner and Amy Yang, Deutsche Bank Research
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%, y/y
%, y/y Photography: Alamy
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