Fed Chair Jerome Powell Concedes Possibility That Higher Rates Cause a Recession

His remarks underscore the challenge facing the central bank as it raises interest rates at the most rapid clip since the 1980s to slow the economy and cool inflation.

Rising fuel costs and supply-chain disruptions from Russia’s war against Ukraine have sent prices up in recent months. Those pressures have added to already-high inflation as demand surged last year from the reopening of the economy and aggressive government stimulus. The central bank is seeking to engineer a so-called soft landing by cooling the economy’s growth enough to lower inflation, but without causing a downturn.

“The events of the last few months around the world have made it more difficult for us to achieve what we want,” Mr. Powell told the Senate Banking Committee on Wednesday. “We’ve never said it was going to be easy or straightforward.”

Mr. Powell said the Fed plans to continue raising interest rates until it sees clear proof that inflation is slowing to the central bank’s 2% target. Officials raised interest rates by 0.75 percentage point last week, the largest increase since 1994, and Mr. Powell and several colleagues have signaled that another such increase could be warranted at their next meeting, July 26-27.

“Over coming months, we will be looking for compelling evidence that inflation is moving down,” Mr. Powell said.

The Fed’s benchmark federal-funds rate, currently in a range between 1.5% and 1.75%, is historically low, but at the levels that prevailed in early 2020, before the pandemic caused central bank officials to slash the rate to near zero. They held the rate near zero until this past March.

Officials’ new projections released last week showed all 18 of them expect to raise the fed-funds rate to at least 3% this year, with most seeing it rising to a range between 3.25% and 3.5% by December. That would exceed by one percentage point the highest level it reached after the 2008 financial crisis, in 2018.

“We anticipate that ongoing rate increases will be appropriate,” Mr. Powell said. He said that borrowing costs had begun increasing last fall in anticipation of Fed rate increases this year, and financial conditions “have now tightened significantly.”

The fed-funds rate, an overnight rate on loans between banks, influences borrowing costs throughout the economy, including rates on mortgages, credit cards and business loans. The Mortgage Bankers Association reported Wednesday that the average 30-year fixed mortgage rose to 5.98% last week, from 5.65% in the prior week, to the highest level since 2008. That was the largest one-week increase in mortgage rates since 2009.

The Fed has faced growing criticism in recent weeks for not acting sooner to withdraw the aggressive economic stimulus measures it deployed through most of last year. Mr. Powell, who was confirmed last month on an 80-19 vote by the Senate to a second term, faced sharp questioning from lawmakers.

“The Fed has largely boxed itself into a menu of purely reactive policy measures,” said Sen.

Thom Tillis

(R., N.C.) in his opening statement prepared for Wednesday’s hearing. Sen.

Richard Shelby

(R., Ala.) said he believed the Fed and the Biden administration had “failed the American people.”

Several Democrats, including Sen. Elizabeth Warren (D., Mass.), warned Mr. Powell against raising rates too aggressively because she believed supply issues over which the Fed had little control were driving prices higher. She said she was worried the Fed would cause a recession without necessarily bringing down inflation.

Republicans, meanwhile, warned Mr. Powell against failing to take decisive action. “Clearly you are aware that you are going to be the person that takes the fall if inflation is not brought under control,” Sen.

Mike Rounds

(R., S.D.) told Mr. Powell.

Mr. Powell told lawmakers that allowing high inflation to become entrenched could be more painful for the economy than a recession. “We can’t fail at that task,” Mr. Powell said.

Mr. Powell’s testimony didn’t directly reference difficult trade-offs the central bank could confront in the next year, especially if its policy steps weaken the job market but don’t bring down inflation in a convincing fashion.

A new research paper from a Federal Reserve economist published Tuesday found slightly more than a 50% chance of a recession over the next four quarters and a two-thirds probability of a downturn over the next two years.

The paper, by Michael Kiley, a senior central bank economist, analyzed four variables—including the unemployment rate, the inflation rate, the difference between yields on Treasury securities and investment-grade-rated corporate bonds, and the difference between yields on short- and intermediate-dated Treasurys—to estimate the risks of a recession.

Last week’s 0.75-point rate increase marked an abrupt change from unusually precise guidance delivered by many members of the rate-setting Federal Open Market Committee, who had indicated ahead of their meeting that they would raise rates by a smaller half percentage point, as they did in May.

Mr. Powell said the committee decided to approve the larger rate rise because of concerns over recent data on inflation and inflation expectations. Fed officials believe expectations of future inflation can be self-fulfilling. If those expectations are rising, the Fed could be required to lift rates to levels that push even harder on the monetary brakes.

The fed-funds rate “is still at a relatively low level,” he said. “In principle, we want to get it to a more neutral-ish level even more expeditiously.”

Write to Nick Timiraos at [email protected]

His remarks underscore the challenge facing the central bank as it raises interest rates at the most rapid clip since the 1980s to slow the economy and cool inflation.

Rising fuel costs and supply-chain disruptions from Russia’s war against Ukraine have sent prices up in recent months. Those pressures have added to already-high inflation as demand surged last year from the reopening of the economy and aggressive government stimulus. The central bank is seeking to engineer a so-called soft landing by cooling the economy’s growth enough to lower inflation, but without causing a downturn.

“The events of the last few months around the world have made it more difficult for us to achieve what we want,” Mr. Powell told the Senate Banking Committee on Wednesday. “We’ve never said it was going to be easy or straightforward.”

Mr. Powell said the Fed plans to continue raising interest rates until it sees clear proof that inflation is slowing to the central bank’s 2% target. Officials raised interest rates by 0.75 percentage point last week, the largest increase since 1994, and Mr. Powell and several colleagues have signaled that another such increase could be warranted at their next meeting, July 26-27.

“Over coming months, we will be looking for compelling evidence that inflation is moving down,” Mr. Powell said.

The Fed’s benchmark federal-funds rate, currently in a range between 1.5% and 1.75%, is historically low, but at the levels that prevailed in early 2020, before the pandemic caused central bank officials to slash the rate to near zero. They held the rate near zero until this past March.

Officials’ new projections released last week showed all 18 of them expect to raise the fed-funds rate to at least 3% this year, with most seeing it rising to a range between 3.25% and 3.5% by December. That would exceed by one percentage point the highest level it reached after the 2008 financial crisis, in 2018.

“We anticipate that ongoing rate increases will be appropriate,” Mr. Powell said. He said that borrowing costs had begun increasing last fall in anticipation of Fed rate increases this year, and financial conditions “have now tightened significantly.”

The fed-funds rate, an overnight rate on loans between banks, influences borrowing costs throughout the economy, including rates on mortgages, credit cards and business loans. The Mortgage Bankers Association reported Wednesday that the average 30-year fixed mortgage rose to 5.98% last week, from 5.65% in the prior week, to the highest level since 2008. That was the largest one-week increase in mortgage rates since 2009.

The Fed has faced growing criticism in recent weeks for not acting sooner to withdraw the aggressive economic stimulus measures it deployed through most of last year. Mr. Powell, who was confirmed last month on an 80-19 vote by the Senate to a second term, faced sharp questioning from lawmakers.

“The Fed has largely boxed itself into a menu of purely reactive policy measures,” said Sen.

Thom Tillis

(R., N.C.) in his opening statement prepared for Wednesday’s hearing. Sen.

Richard Shelby

(R., Ala.) said he believed the Fed and the Biden administration had “failed the American people.”

Several Democrats, including Sen. Elizabeth Warren (D., Mass.), warned Mr. Powell against raising rates too aggressively because she believed supply issues over which the Fed had little control were driving prices higher. She said she was worried the Fed would cause a recession without necessarily bringing down inflation.

Republicans, meanwhile, warned Mr. Powell against failing to take decisive action. “Clearly you are aware that you are going to be the person that takes the fall if inflation is not brought under control,” Sen.

Mike Rounds

(R., S.D.) told Mr. Powell.

Mr. Powell told lawmakers that allowing high inflation to become entrenched could be more painful for the economy than a recession. “We can’t fail at that task,” Mr. Powell said.

Mr. Powell’s testimony didn’t directly reference difficult trade-offs the central bank could confront in the next year, especially if its policy steps weaken the job market but don’t bring down inflation in a convincing fashion.

A new research paper from a Federal Reserve economist published Tuesday found slightly more than a 50% chance of a recession over the next four quarters and a two-thirds probability of a downturn over the next two years.

The paper, by Michael Kiley, a senior central bank economist, analyzed four variables—including the unemployment rate, the inflation rate, the difference between yields on Treasury securities and investment-grade-rated corporate bonds, and the difference between yields on short- and intermediate-dated Treasurys—to estimate the risks of a recession.

Last week’s 0.75-point rate increase marked an abrupt change from unusually precise guidance delivered by many members of the rate-setting Federal Open Market Committee, who had indicated ahead of their meeting that they would raise rates by a smaller half percentage point, as they did in May.

Mr. Powell said the committee decided to approve the larger rate rise because of concerns over recent data on inflation and inflation expectations. Fed officials believe expectations of future inflation can be self-fulfilling. If those expectations are rising, the Fed could be required to lift rates to levels that push even harder on the monetary brakes.

The fed-funds rate “is still at a relatively low level,” he said. “In principle, we want to get it to a more neutral-ish level even more expeditiously.”

Write to Nick Timiraos at [email protected]