A Game of Chicken?

Will the Fed raise interest rates aggressively? Or will the economic threat of recession force the Fed to slow its pace of rate increases? The outcome in what is shaping up as a sort of “game of chicken” remains to be seen.

Inflation is raging – there is no question. Prices of items as basic as eggs, butter and milk are increasing at crazy high rates. This is not to mention price increases for meat and produce. Gas prices have become crippling, just as workers return to corporate offices even part-time. Restaurants are still raising prices for diners. Home prices are still going up, although the recent rise in mortgage rates may cool the craziness. Wage increases are still happening (and not keeping up with inflation but also feeding into inflation) although there may be moderation in wages coming. The list goes on.

The Fed has good intentions to adjust rates to as ideal a level as possible to tame inflation while avoiding a deep recession.

In the meantime, the US Federal Reserve’s task is to slow or (come close to) eliminating inflation while maintaining healthy levels of employment. The Fed’s primary tool is the ability to adjust short-term interest rates. Lately, the direction of rates is UP – and UP more than the country has seen in over 20 years. Here is where the “game of chicken” with the Fed vs. the Economy comes in:

  • Raise rates too much and/or too fast, then risk a recession.
  • NOT raise rates enough or fast enough, then risk continuing spiraling inflation.

AND – the catch is that decades and decades of inflation data show how inflation becomes worse because when inflation sticks around longer, people’s inflation expectations increase. Today inflation has stuck around longer and is higher than in nearly 50 years.

In order to “fix” the situation, the US Fed is finding itself relying on quickly changing – and confusing – data. The data changes quickly because consumer psychology and behavior are constantly changing; the data is confusing because the number of job openings is historically gigantic versus the smaller number of workers looking for jobs – globally. Workers have been quitting jobs at a historically high rate, although recently slowing a bit.

This state of affairs is exacerbated amidst emergence from the global pandemic and massive supply chain disruptions.

Games of chicken typically end when one side backs down. A collision – or bad ending – is when neither side backs down. The Fed has good intentions to adjust rates to as ideal a level as possible to tame inflation while avoiding a deep recession; the economy is more unpredictable and at times uncontrollable. The outcome would best play out as gradually as possible.

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