The US Federal Reserve (Fed), after raising interest rates by 75 basis points on Wednesday, is expected to do so again in smaller steps in December and February. The growth rate of consumer prices will decrease from the current 8% to 2%, while unemployment will rise slightly to almost 4.5%. This is the scenario the Fed is looking forward to. But what if inflation does not return to 2%, but remains somewhere higher, for example, by 3%? That’s when things can start to get scary. Bank Chairman Jerome Powell has only one tool at his disposal to curb price escalation: tried-and-true interest rates. However, much in today’s context is both new and unusual. Consumers continue to spend even when goods and services become more expensive. Some indicators indicate that inflation is declining, such as a sharp reduction in production times. Other signs still indicate that the economy is on the rise, such as an increase in the number of jobs available to fill in September.

Target 2% and the risk of it stabilizing at higher levels.

For a number of years, the Federal Reserve has struggled to bring inflation up to its official 2% target. Now, how long it will take to reach this level depends on anyone’s imagination. Global trade flows have slowed and energy costs may remain high as the war rages in Ukraine. The Brookings Institution estimates that about 4 million people will be out of work due to ongoing coronavirus symptoms. And it could make America less productive or increase healthcare costs. In addition, according to the minutes of the September meeting, Fed officials say that the growth rate at which the economy begins to overheat is lower than previously thought. The nightmare scenario for the central bank is one in which inflation falls to above its target and stays there. Unlike the present, the path to the bank would be much less clear. One option would be to continue the tightening policy. However, any rate hike would increase stress on borrowers and push stock markets lower. Technically the Fed shouldn’t care, but it could become a political issue if wealthy Americans held in securities evaporate. Some Democrats are already arguing that the Fed’s rate hike is hurting the poor. Some Republicans accuse Powell of allowing unchecked inflation. An alternative would be goal transformation. The idea that prices should rise by about 2% is more art than science. It gained widespread adoption after being adopted by the Bank of New Zealand in 1990 and then formally adopted by the Fed in 2012. Interest rate regulators fear that consumer expectations could become “unreasonable,” as Jerome Powell points out, leading workers to increasingly demand higher wages. and encouraging faster price increases.

However, consumers may give up as their savings deplete. Finally, raising interest rates could trigger a recession, a painful situation that in the past led to a rapid decline in inflation.