the money game

The Fed Just Raised the Odds of a Recession

Jerome Powell speaks at a news conference following the interest-rate hike. Photo: Win McNamee/Getty Images

The Federal Reserve pushed up the odds that the country will fall into a recession on Wednesday when it tightened up the flow of money in the most aggressive move in 22 years.

Led by Jerome Powell, the central bank has essentially put the economy in reverse and jammed on the accelerator in a bid to speed away from inflation, stoked by $5 trillion in stimulus, more than two years of practically free credit, and a global trade system jammed up by the lingering effects of the pandemic. Inflation is running at a 41-year high with few signs of gas and food prices coming down any time soon. It kicked off a program that will dump $47.5 billion in debt into the market in June — and double that starting in September — essentially swamping Wall Street with more risk as it grapples with global uncertainties. It’s very unlikely that this is a one-time move, with Wall Street predicting more half-point hikes to come, perhaps at each of the five next meetings this year. It’s possible that the Fed will be able to keep inflation down without sending the economy into an extended period in the red. During a press conference after the announcement, Powell said the central banks has “a good chance to restore price stability without a recession, without a severe downturn, and without materially higher unemployment.” But even former Fed governors find that to be an unlikely scenario.

The Fed’s mandate is to keep inflation low and employment high — two goals that are especially at odds now. Earlier this week, the Labor Department recorded the highest level of job openings ever for March: 11.5 million, more than double the number of people who are unemployed. (When you factor in the higher levels of people who are out of the workforce and not looking for jobs — and consider that about two-thirds of the openings require a degree or some kind of specialization — the picture is less rosy, however.) On top of that, 4.5 million people quit their jobs that month, another all-time high. This has had the effect of pushing up wages, though not enough to keep up with inflation. Still, Powell has called the number of job openings “unhealthy,” essentially a sign that the economy is running too hot, and it needs to be cooled off.

One of the things that makes the Fed so powerful is its blunt tools. When interest rates rise, they rise for everyone. When the central bank dumps debt into the markets, it affects the way markets operate in ways that aren’t well understood, since a program like this has happened once before, starting in 2017, and at a smaller scale. This means that credit gets more expensive for everyone, and since that is the lifeblood of the U.S. economy, it means that people will probably stop spending so much and then it will get harder for businesses to pay for goods and make payroll.

As far as central banks go, the Fed’s regime of rate hikes is an outlier. Inflation isn’t just a problem in the U.S., after all. The European Central Bank has kept its interest rates negative (investors pay Europe money to hold onto their cash) and will consider buying up even more debt if the E.U. enters a recession, which is increasingly likely. China is expected to go in a similar direction, even as it grapples with a teetering real-estate bubble and manufacturing shutdowns. Even Russia, largely isolated from the global financial system, has started to lower its interest rates. Essentially, rate hikes are a way to strengthen what’s key to the U.S. economy, which is the financial system. When rates rise, the financial-services sector collects more money in interest on everything from credit cards to mortgages, thus making more profit. For the broader economy, higher rates also have the effect of keeping dollars from leaving the country — effectively lessening the demand that’s caused the trade chokepoints in China — and making it more attractive for people to stash them in, you guessed it, bank accounts.

When countries keep their rates low, or sink them even further, usually this is done with an eye toward protectionism. The intended effect is often to juice the economy while devaluing the currency to make goods cheaper on the international market, with the hopes that some richer country will spend so much that the economy will turn around. This has already been playing out with the U.S., since GDP shrank by 1.4 percent last quarter, in large part because of the spike in imports.

So why isn’t the Fed being protectionist? I spoke with Stefan Eich, an government professor at Georgetown University whose forthcoming book, The Currency of Politics: The Political Theory of Money from Aristotle to Keynes, is a deeply researched and very well-written history of money’s role in political thought. He said that, in a sense, it is — just for a small subset of the economy: Wall Street. As the U.S. has shown in its weaponization of the financial system, one of its most powerful exports is its own currency system, and this has had the effect of protecting that industry, he said.

“What’s being protected here is the dollar’s role in the global system and the role of U.S. finance attached to it,” Eich said. “We usually don’t use the term ‘protectionism’ for it, but protectionism usually means you’re protecting a certain sector of the economy in a global import-export environment. We tend to think of industrial output in that area, and not financial services, and not the kind of hegemonic currency status, but it’s certainly what’s going on here.” The effect here is that you’re likely to see the economy look more like banks — creating insurance products or selling credit cards. The broader financial industry, including real estate and insurance, is the largest sector of the economy, after all. “There’s a way in which that strong dollar keeps in place a whole system of U.S. financial services,” he said.

The Fed Just Raised the Odds of a Recession