According to the Bureau of Economic Analysis, GDP growth in the first quarter of this year was 1.1%. That’s a slowdown from the last two quarters. Gross domestic product grew at a 3.2% rate in the third quarter of last year, then slowed to a 2.6% rate in the fourth quarter.
This current slowdown likely means a recession is coming. Most economists see slower growth in the second quarter, then negative growth for the rest of the year. That is a recession. The Federal Reserve will take this recent data into account when it meets next week to decide what to do with interest rates.
Inflation is a cancer that must be eliminated as soon as possible. The Fed has the primary responsibility for keeping prices stable in the economy.
Many will argue that since the economy is headed toward recession, no further rate hikes are needed. That’s because when the economy is in recession, total demand falls. Since the reason for the rate hikes is to reduce demand, no rate increase is necessary.
But the week after the Fed meets, the consumer price index (CPI) for the month of April will be released. That will probably show an increase of about 0.5%. That will mean the 12-month inflation rate will increase for the first time in nearly a year. The Fed will then consider further rate increases when it meets again in mid-June.
The CPI for the month of May will be released on June 13. That’s one day before the Fed’s June meeting starts. While it is difficult to forecast the monthly CPI for May, the indications are that the number will be higher than the Fed would like to see. If that is the case, the Fed may move to raise interest rates again during that June meeting.
Those two rate hikes will reduce total demand in the economy, which will reduce the inflation rate. It will, unfortunately mean a recession is much more likely.
Because of the Fed’s shockingly irresponsible monetary policy in 2021, it is now forced to be very aggressive with interest rate increases. For the entire year in 2021, with inflation increasing monthly, the Fed incorrectly kept interest rates near zero and kept vastly increasing the money supply mostly through their bond buying program.
Finally in March 2022, it ended the bond buying program and raised interest rates by a meager 25 basis points. That did little to reduce inflation. By June 2022 the annual inflation rate reached 9.1%. Finally, the Fed realized that price stability is the top priority for monetary policy. Finally, a year age, it became very aggressive with rate hikes.
Today the Federal Funds rate is in the 4.75% to 5% range. After the expected 25 basis point increase next week, the rate will be in the 5% to 5.25% range. While further rate increases will worsen the recession, higher rates are needed to bring the inflation rate down.
Some argue that the Fed’s rate hikes will lead to an increase of 2 million workers added to the unemployment rolls. That is true and will certainly cause pain for the 2 million households impacted. But the Fed’s actions will finally reduce inflation so that the other 140 million households will get relief from the ever-increasing prices that have strained family budgets and led to a decline in the standard of living.
Inflation is a cancer that must be eliminated as soon as possible. The Fed has the primary responsibility for keeping prices stable in the economy. Rapidly rising prices lead to an economy that doesn’t work for anyone. Workers want to see real gains in wages, so they demand wage increases greater than the inflation rate.
That leads to a nasty wage-price spiral.
Business can’t adequately plan for the future with uncertainty in material prices and labor costs. And there is a negative psychology that develops when prices continue to rise. This leads to expectations of higher prices which will worsen inflation and permanently embed inflationary expectations into the economy..
The first quarter GDP data shows the economy is slowing. Until there is clear evidence that inflation has moderated, the Fed’s action to reduce inflation will slow growth. But this summer we will be in a difficult position. Inflation will still be high and economic growth will be negative.
Welcome to another round of stagflation.
Michael Busler is a public policy analyst and a professor of finance at Stockton University in Galloway, New Jersey, where he teaches undergraduate and graduate courses in finance and economics. He has written op-ed columns in major newspapers for more than 35 years.
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