What will be needed remains highly uncertain. Just a year ago, Fed officials expected the federal funds rate to be below 1% right now. The forecast for next year could be no less mistaken, so humility is in order.
This business cycle is highly unusual, in some positive ways: Household and business balance sheets are in very good shape, and there’s little risk of a financial cataclysm like what happened in 2008. It’s reassuring that, amid the most rapid rise in short-term rates since the early 1980s, the only significant financial blowups have occurred in crypto, with little to no contagion.
The unique economic background also means that the Fed holds unusual sway. It can induce a recession (as seems likely), but output should rebound relatively quickly when the central bank decides that its inflation-fighting job is done. With short-term rates likely to peak above 5%, it will have plenty of ammunition to support the recovery.
This may help explain the performance of the US stock market, which is well above the lows it reached earlier this year. Investors seem to be anticipating the recovery following the downturn. Unfortunately, this optimism has a downside: It means that the Fed will have to work harder, tightening monetary policy more than it otherwise would, to achieve its 2% inflation objective.
This article was provided by Bloomberg News.