No one really knows how high or for how long interest rates will need to go. And if the US central bank does too little or too much, the domino effects could bring on a recession, writes Raghuram Rajan.
The US Federal Reserve is clearly determined to bring down inflation. But no one really knows how high it will have to raise its policy interest rate – and how long it will have to keep it there – to achieve its objective. Many are thus wondering whether the Fed will bringUS Inflation is coming down, partly because snags in supply chains have been sorted out, but also because demand is weakening. Higher interest rates have slowed home purchases, and hence housing construction.
It has concluded that if the economy slows too much, it can always be stimulated back to growth through rate cuts. Hence, the consensus is that the Fed will, as that would still allow it to keep any downturn mild by cutting rates. Indeed, market prices suggest the Fed will be back to cutting rates later this year.
In fact, some are still hiring, encouraged by the prospect of recruiting more high-quality workers now that the big firms have shut their doors. Now consider another potential domino. We have just gone through a three-year period in which corporate bankruptcies fell, owing not least to pandemic-related fiscal support. Yet notwithstanding some recent signs of corporate distress, it would seem that many more wounded firms ought to be folding. Why aren’t they?
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