Facing a strong economy, Fed puzzles over how to slow it down
Inflation is too high, but the economy is growing like gangbusters. The job market shows some signs of slowing, but has clocked 33 consecutive months of gains. There's no recession in sight, even though the Federal Reserve has pushed interest rates up faster than it has in decades.
This is the jumbled picture confronting central bankers as they kick off their two-day policy meeting on Tuesday. The widely held view is that Fed leaders will hold interest rates steady - and they might even be done raising rates altogether. But in highly technical debates from its ornate board room, a key Fed committee will grapple with exactly where the economy is headed and how to wade its way through still more uncharted waters for monetary policy.
"The data is really strong, but these were not things on people's bingo card," said Derek Tang, an economist at research firm LH Meyer/Monetary Policy Analytics. "How do they untangle all of these things?"
In many ways, the Fed has been untangling a web of data ever since the pandemic torpedoed through the economy more than three years ago. Now, officials are trying to understand why major economic engines like consumer spending, the job market and overall growth have not responded to sharply higher interest rates as Economics 101 would suggest.
This time last year, for example, an overwhelming share of economists were convinced that the country would slump into a recession because of the Fed's sprint to hoist interest rates. Instead, data released last week showed a fifth straight quarter of growth, with the economy expanding at an annualized rate of 4.9 percent from July to September, the strongest pace since 2021.
Meanwhile, policymakers expected households and families would pull back on spending, as they buckled under the weight of high prices for groceries, gas and other essentials. But consumers have bested those predictions time and again, shrugging off inflation and higher interest rates alike and spending big on concert tickets, high-end vacations and new cars. Retail sales in September rose 0.7 percent over the month before, far above expectations.
And while the job market may be showing some signs of cooling - fewer job openings and tamer wage growth than earlier in the pandemic - there's been nothing resembling massive layoffs or rising unemployment.
Fed officials, then, are left to sort out why.
In remarks before the Economic Club of New York earlier this month, Fed Chair Jerome H. Powell said demand is being driven, in large part, by a strong labor market, as wages outpace inflation and people have more money to spend. He also pointed to groups that just aren't that hampered by high borrowing costs: homeowners who bought homes when mortgage rates were still low, or businesses that termed out their debt and now aren't feeling tighter financial conditions.
"It really is a story of much stronger demand," Powell said. "There may be some ways the economy is less affected by interest rates. It's hard to know precisely."
For the Fed, though, interest rates are the main tool for combating inflation and getting the economy on a more sustainable path. The Fed's benchmark rate, known as the federal funds rate, falls between 5.25 and 5.5 percent, the highest level in 22 years. Central bankers have left the door open for another quarter-point rate increase, possibly at their final meeting of the year in December. But Fed watchers increasingly bet the central bank is done hiking rates, and that leaders will instead hold borrowing costs high for as long as it takes to get inflation back to 2 percent. (Using the Fed's preferred gauge, inflation is running at 3.4 percent. It's come down a lot from a high of 7 percent in June 2022, using that metric.)
The thinking can be somewhat counterintuitive. On the one hand, officials have long said workers, employers and the overall economy will have to go through "pain" until the Fed finishes its inflation fight. But on the other hand, officials and observers are starting to wonder if the economy will react to steep rates with what the models predict: subpar growth, a weak job market or a pullback in spending.
In a speech late last month, Chicago Fed President Austan Goolsbee said there are risks to "believing too strongly" in the inevitable, large trade-offs between inflation and the job market.
"Inflation still needs to come down. But we also can't lose sight of the fact that the Fed has the chance to achieve something quite rare in the history of central banks - to defeat inflation without tanking the economy," Goolsbee said. "If we succeed, the golden path will be studied for years. If we fail, it will also be studied for years."
He continued: "Let's be prepared to recognize when historical lessons might not work that well for today's environment."
What that means for monetary policy, though, may not be worked out for some time. In the near term, Fed officials say they'll make decisions about rates meeting by meeting, based on how data on inflation, jobs, wages and growth continue to unfold. Zoomed out a bit more, central bankers still don't know how much more the economy will slow from their drastic moves over the past 19 months.
And it may take even more time to see how - or whether - the Fed manages to curb an economy that is barreling ahead.
"That's the high stakes thing about this: If growth is strong, do [they] have to be extra tight?" said Skanda Amarnath, executive director of Employ America, a think tank that pushes for the economy to run hot. "That's been the narrative. The question is, 'What goes against that?'"
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