The Federal Reserve will raise interest rates by another percentage point as it fights high inflation, according to three top economists.
Rates are likely to peak at about 5.5% and will remain higher for longer to contain spiraling prices of everything from food to fuel, professors Wenxin Du, Randall Kroszner and Raghuram Rajan said Tuesday at a University of Chicago Booth School of Business event.
“I do think the Fed is going is going to hold, and hold for a while,” said Kroszner, a former Fed governor. “Inflation will come down 200 basis points over the year, maybe 300 basis points, but the Fed will keep rates up at 5.5%.”
Inflation soared to a 40-year high last year as global demand for goods and services rebounded with economies reopening and the war in Ukraine upending commodity markets. While prices have come down since, they remain well above the Fed’s 2% target.
The Fed “certainly has caught up with the sense that it was behind the curve, but the question is, for how long does it have to tighten, and how long does it have to stay tight?” asked Rajan, who was governor of the Reserve Bank of India from 2013 to 2016.
Fed officials raised interest by 50 basis points last month to 4.3% and projected rates at 5.1% this year, according to their median projection.
Kroszner, Rajan and Du saw the Fed keeping rates high to prevent inflation from bouncing back.
In the 1970s, the Fed kept on easing monetary policy when inflation slowed, only to see it pick up again. As a result, the bank lost credibility as an effective tool to control prices and was forced to boost rates well above 10%, Kroszner said in an interview at the event.
Still, the fact that inflation expectations have remained in check means the U.S. central bank can be more measured.
“That’s the enormous difference between late 1970s, early 1980s and today,” he said. “The Fed didn’t lose that credibility with the markets, and so it certainly needs to raise rates, but it doesn’t need to raise rates as much as they did back then.”
Rate hikes will likely result in a mild recession at the end of this year, the economists said. Du cautioned that any downturn will be short-lived, while Rajan believes the Fed will be very cautious not to be blamed for engineering a recession.
Keeping rates higher even as inflation starts to fall is one of the tools the Fed will use to keep real rates tighter until a clear downtrend emerges, Kroszner said.
“People have lost context because it’s been so long since inflation was so high,” he said. “This is one of the reasons why the market isn’t getting this, because they haven’t seen this behavior in decades.”
This article was provided by Bloomberg News.