The U.S. central bank will raise its benchmark policy rate above 4% and hold it beyond 2023 in its bid to stamp out high inflation, according to the majority of leading academic economists polled by the Financial Times.
The latest survey, conducted in partnership with the University of Chicago Booth School of Business’s Initiative on Global Markets, suggests the Federal Reserve is far from ending its monetary policy tightening campaign. It has already raised interest rates this year at the most aggressive pace since 1981.
Floating near zero as recently as March, the fed funds rate is now between 2.25% and 2.50%. The Federal Open Market Committee reconvenes Tuesday for a two-day policy meeting, during which officials are expected to implement a third consecutive hike of 0.75 percentage points. This decision will bring the rate to a new target range of 3% to 3.25%.
Nearly 70% of 44 economists polled Sept. 13-15 believe the federal funds rate this tightening cycle will peak between 4% and 5%, with 20% believing it will need to rise above that level.
“The FOMC still hasn’t figured out how much it needs to raise rates,” said Eric Swanson, a professor at the University of California, Irvine, who predicts the federal funds rate will eventually hit between 5 and 6%. “If the Fed wants to slow the economy now, it needs to raise the funds rate above [core] inflation.”
While the Fed typically targets a 2% rate for the “core” Personal Consumption Expenditure (PCE) price index – which excludes volatile items like food and energy – it is also closely watching the consumer price index. Inflation picked up unexpectedly in August, with the core index rising 0.6% for the month, or 6.3% from a year earlier.
Most respondents expect core PCE to decline from its most recent July level of 4.6% to 3.5% by the end of 2023. But nearly a third expect it still exceeds 3% 12 months later. Another 27% said it was “about as likely as not” to stay above that threshold at this time, indicating great unease with entrenched high inflation. deeper into the economy.
“I’m afraid we’ve reached a point where the Fed runs the risk of seeing its credibility seriously eroded, and so it needs to start being very aware of that,” said Jón Steinsson of the University of California, Berkeley.
“We all hoped that inflation would start to come down, and we were all disappointed again and again.” More than a third of economists polled warn that the Fed will fail to adequately control inflation if it does not raise interest rates above 4% by the end of the year.
Beyond raising rates to a level that constrains economic activity, the majority of respondents believe the Fed will keep them there for an extended period.
Easing price pressures, instability in financial markets and a deteriorating labor market are the most likely reasons the Fed would suspend its tightening campaign, but no cut in the fed funds rate is expected. before 2024 at the earliest, according to 68% of respondents. Of these, a quarter do not expect the Fed to lower its benchmark policy rate until the second half of 2024 or later.
Few believe, however, that the Fed will step up its efforts by shrinking its balance sheet by nearly $9,000,000,000 via the outright sale of its holdings of mortgage-backed securities.
Such aggressive action to cool the economy and stamp out inflation would have costs, a point Jay Powell, the chairman, has made in recent appearances.
Nearly 70% of respondents expect the National Bureau of Economic Research – the official arbiter of the start and end of US recessions – to declare one in 2023, with most agreeing that it will will produce in the first or second trimester. This compares to the roughly 50% that sees Europe tipping into a recession by the fourth quarter of this year or earlier.
Most economists expect a US recession to last two or three quarters, with more than 20% expecting it to last four or more quarters. At its peak, the unemployment rate could be between 5% and 6%, according to 57% of respondents, well above its current level of 3.7%. A third see it eclipse 6%.
“It’s going to fall on workers who can least afford it when we have an increase in unemployment due to these rate increases at some point,” warned Julie Smith of Lafayette College. “Even if it’s small amounts – one or two percentage points of unemployment increases – it’s a real pain for real households that aren’t prepared for these kinds of shocks.”
An easing of supply-side constraints related to the war in Ukraine and Covid-19 lockdowns in China could help minimize how much the Fed needs to dampen demand, which means a less severe economic contraction at the end,” said Şebnem Kalemli-Özcan at the University of Maryland. But she warned that the outlook was very uncertain.
“Obviously it’s one shock after another, so I’m not sure it’s going to happen right away,” Kalemli-Özcan said. “I can’t give you a time frame, but it’s going in the right direction.”