THE Federal Reserve faces a growing risk of making a policy mistake, tipping the U.S. economy into a recession, as it confronts decades-high inflation that’s proving more persistent and broad-based than policy makers expected.

After holding interest rates near zero since the start of the pandemic, Fed Chair Jerome Powell and his colleagues are poised to embark on a credit-tightening campaign next month, with some economists forecasting an outsized half percentage-point increase to start the cycle.

Some economists worry that, with price gains far above its 2 percent target, the Fed will be pressured into overdoing it — pushing the economy into a downturn by rapidly raising borrowing costs for consumers and companies, and cratering financial markets that have grown used to its ultra-expansionary monetary policy.

Economists from both sides of the political spectrum see rising risks of a recession. Former Fed Governor Lawrence Lindsey, who served in the White House under Republican President George W. Bush, puts the odds of a downturn by the end of next year at above 50 percent — triggered by a meltdown on Wall Street.

“When you’re wrong in one direction and you’re painfully wrong, you’re going to have to end up with too much heavy lifting to go in the other direction,” Lindsey, who now heads his own consulting firm, said of what he sees as the Fed’s delay in recognizing and responding to the budding inflation problem.

Ex-Treasury Secretary and Democrat Lawrence Summers agreed. “The Fed has allowed itself to get far further behind the curve” in battling inflation, Summers, who is a paid Bloomberg contributor, said. “The risk a recession will start in the next 30 months is certainly 50 percent.”

Traders in the money markets are wagering on roughly six quarter percentage-point increases by the Fed this year. Layered on top of those hikes will be a yet-to-be-specified reduction in the Fed’s balance sheet, which now stands at US$8.9 trillion. That will take liquidity out of the financial system — potentially unsettling bond and stock markets.

“I don’t think we’ve priced in balance-sheet tightening really in the equity market at all,” Bloomberg Intelligence chief equity market strategist Gina Martin Adams said. “We’ve just barely started talking about it.”

For his part, Powell is betting that a judicious tightening of monetary policy, combined with an easing of supply-chain bottlenecks and the winding down of the federal government’s pandemic-relief programs, will help rein in inflation without upending the economic expansion.

But he’s acknowledged that he’s been surprised by the potency of the price pressures, and he’s vowed the Fed will do what it takes to prevent elevated inflation from becoming embedded in the economy.

(SD-Agencies)