Federal Reserve risks recession by raising interest rates to fight inflation

The Federal Reserve is expected to raise interest rates again this week by three-quarters of a point. Fed Chair Jerome Powell has made it clear he wants to substantially curb the rate of inflation. But there are serious concerns the Fed could overreact and tip the economy into a recession. Economist Paul Krugman, who's been writing about this in The New York Times, joins Judy Woodruff to discuss.

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  • Judy Woodruff:

    The Federal Reserve is expected to raise interest rates again by three-quarters-of-a-point tomorrow.

    Fed Chair Jay Powell has made it clear that he wants to substantially curb the rate of inflation. But there are some concerns that the Fed could overreact and end up tipping the economy into a recession.

    The latest warning signs? New home sales, as we just reported, were down for the fifth time this year, and consumer confidence slid for the third month in a row.

    Economist Paul Krugman has been writing about this in The New York Times. And he joins me now.

    Paul Krugman, welcome back to the "NewsHour."

    So, tell us, what do you expect the Fed to do tomorrow? And do you think it's the right thing?

  • Paul Krugman, Columnist, The New York Times:

    Well, they are going to do, unless — it would be a huge surprise if they don't do a three-quarters-of-a-percentage-point increase, which, I have to say, I'm a big monetary dove most of the time.

    I think they do need to do this. I think they needed to do the rate hikes they have done so far, because the — although inflation is a global phenomenon, and most of the inflation that we're seeing is something that we're sharing with the rest of the world, it was also pretty clear that the U.S. economy was overheated.

    At the beginning of this year, we were just running too hot, and the Fed needed to cool things down. The important question is what they do going forward. So I'm actually going to be much more interested in what they say than what they do. They're going to — they're going to raise by 75 basis points.

    But are they going to show a willingness to start to maybe ease off on further rate hikes in the light of day there? Because there's a lot of very sort of short-term data coming in now that suggests that inflation is coming down substantially, and also a lot of data coming in suggesting that the economy is weakening substantially.

    So, the question really is going to be, is the Fed going to signal a willingness to maybe start to loosen up a bit in the near future?

  • Judy Woodruff:

    So, you're more concerned at this point about the signals they're going to send tomorrow and what happens down the road.

    So how worried are you hear that what they do could tip us into a recession?

  • Paul Krugman:

    Oh, I mean, it's a very real possibility.

    I mean, you're trying to do something. What the Fed is trying to do is cool things down, slow the economy down, flatten the — flatten the slope, without tipping it down to the point where the economy goes into a plunge that's unnecessary, that is deeper than is necessary to cooling inflation.

    It's not as if they have any kind of exact control. We're not talking about precision fine-tuning of the economy. In fact, the — tomorrow's meeting is going to take place at almost the worst possible time. There's going to be a lot of data coming in the next few weeks, not the GDP, but, more important, we're going to be beginning some readings on labor costs on Friday that everybody is — in my circle is very anxious to see, and lots more to come.

    So the Fed is being obliged to take — by its schedule, to take a major decision really very much in the dark. And, no, the chance of — the chance of getting it wrong is very high, not because the people at the Fed are bad, but because it's a very, very difficult job under these conditions.

  • Judy Woodruff:

    And explain to us why we should be more worried about a recession than we already are about inflation. I mean, people are suffering right now with higher prices.

  • Paul Krugman:

    No, and we are — we should be worried about inflation.

    And it is clearly unacceptable. Inflation needs to be brought down. But there's really not much question about that the Fed will do enough to bring inflation under control. The markets believe that. If you look at market expectations of what inflation is going to be over the next year, they have gone from 7 percent to — a few months ago to a little over 2 percent now.

    So, the markets really are convinced that the Fed is going to do whatever it takes to bring inflation under control. So, now the risk is that they do more than it takes. So it's not a question that inflation is OK and a recession is bad. It's that inflation is something that we know they're going to deal with.

    And the question is, are they sufficiently sensitive to the risk of overdoing it and causing an unnecessary recession?

  • Judy Woodruff:

    And, in brief, why is a recession a bigger worry for you?

  • Paul Krugman:

    Well, a recession means that people lose jobs.

    I mean, a higher cost of living, which means that your salary doesn't stretch as far, is a bad thing. Not getting a salary at all is an even worse thing. So there are much — in terms of the actual economic losses, the — the losses from inflation are real. They're — although the ones that hurt the most are the things over which we — the Fed has no control, like the price of oil.

    But the losses of having productive workers not being allowed to produce because the economy is depressed, the output, the stuff we could have been producing that we don't because factories have been shut down, because businesses have been shut down, those are always huge economic costs.

    And we really don't want to incur those. Inflation is a bad thing, but the Great Depression was a really, really bad thing. So you don't want — you really, really don't want a recession if you can avoid it.

  • Judy Woodruff:

    For sure.

    Paul Krugman, you wrote a column just the other day acknowledging that you have been wrong in forecasting. You didn't sufficiently expect that inflation was going to be as bad as it's been. So, as you think about whether the Fed could overreact, how do you square those two things?

  • Paul Krugman:

    Well, the Fed was wrong, too.

    I mean, if there was a — there wasn't a whole lot of air between my views about the future inflation in early 2021 and those of the Fed. And we all — the world is a complicated place. And if you never make a mistake, you're not taking enough risks.

    And the Fed was concerned to avoid mistakes it has made in the past, when it has been much too tight. And they failed to see. There were some things that there were no — really nobody's fault, or nobody's fault except Vladimir Putin's, like that the rise in energy and food prices.

    But the U.S. economy got overheated to a greater degree than they or I expected and — but the point is that they have reacted to that. The Fed has tightened a lot. And even more important, markets have priced in the fact that the Fed is going to tighten and will continue to tighten somewhat more.

    So, mortgage rates, which is probably the most important point — place where what the Fed does affects real people's lives, largely through mortgage rates, which affect housing, which affect construction, which affect employment and so on through the economy, mortgage rates have really soared this year.

    So the Fed has already reacted to that mistake and has tried to undo the damage. And, at this point, the problem is, will they do too much?

  • Judy Woodruff:

    And, finally, Paul Krugman, people watching this, what should they take away tonight, in terms of your view of how worried you are about a serious recession coming?

  • Paul Krugman:


    I think that we're probably not headed for anything remotely like what we went through in the — after the 2008 financial crisis. For one thing, the Fed is not stupid. They're not — things are not out of control. Inflation is high, but they're reacting to that.

    There don't appear to be really huge structural weaknesses. It doesn't look like the banking system is going to collapse. The consumers, many of them have some cushion of savings. So we're probably talking about something, at worst — I'm showing my age because this doesn't sound like that long ago — but something like the 2001 recession after dot-com bubble burst.

    We're talking about a relatively mild recession. But, of course, even a relatively mild recession means that millions of people's lives are seriously disrupted. So, catastrophe, no, but some pain is a, definitely, real possibility.

  • Judy Woodruff:

    Paul Krugman, we appreciate it. Thank you.

  • Paul Krugman:

    Thank you.

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