Can the Federal Reserve prevent a Recession?

The housing market is driven by the balance between supply and demand. Supply cannot be increased significantly quickly, so the only way for the booming housing market to slow is if demand drops. And the most likely causes for a drop in demand are either a major geopolitical development – such as Russia invading Ukraine and the US and its NATO partners deciding to respond militarily – or a recession.

Since World War II there has been a consistent pattern of the Federal Reserve hiking interest rates to control inflation and thereby triggering a recession. With the Fed finally acknowledging in late November that inflation was not transitory and committing to end its bond buying spree and also raise interest rates, will it be able to avoid a recession? Can this time be different?

The Boston Globe recently carried an excellent article on this subject by Jim Puzzanghera: ‘A hellishly difficult task.’ Can the Federal Reserve lower inflation without causing a recession?

“The virus is unpredictable. People’s responses to the virus are unpredictable. It’s not a garden variety business cycle by any means,” said Donald Kohn, a senior fellow at the Brookings Institution think tank who served as Fed vice chair from 2006-10. “It’s much harder to peer into the future and know how to calibrate your monetary policy.”

Bernard Baumohl, chief global economist at the Economic Outlook Group, a forecasting firm, was more blunt. “The Fed has a hellishly difficult task right now,” he said. “There is absolutely no history for the Fed to lean on to deal with this kind of inflation.”

Most economists predicted last spring that high inflation would be temporary, pointing to the supply chain problems caused by restarting the US and world economies. But some economists warned the $1.9 trillion COVID aid bill enacted last March risked fueling longer-lasting inflation by pumping too much money into the already recovering US economy.

By last June even I was writing: “Should inflation prove to be more persistent than the Fed expects, then it is likely that the Fed will have to start to increase interest rates sooner and move them up more quickly than it currently expects. And mortgage rates would follow.
The Fed’s two goals of price stability and maximum sustainable employment are known collectively as the “dual mandate.” In explaining its policy of keeping interest rates low – in part by buying large quantities of Treasuries and Mortgage-Backed Securities, the latter helping to keep mortgage rates low – the Fed refers to the still high level of unemployment.
I have to admit that I struggle to understand how low interest rates, which boost asset classes such as stock prices and real estate, are helping to boost employment. Lower interest rates benefit those who own assets which appreciate.
I would like to see the Fed start to reduce (taper) its bond buying, while encouraging Congress to focus on removing barriers to employment – by providing increased child care allowances, for example. In other words, deal directly with the problem rather than hoping that benefits will trickle down somehow.”

Some quotes

We have to achieve price stability, and I believe we will, and I’m confident we will,” Powell told the Senate Banking committee on Jan. 11 during a hearing on his renomination by Biden for four more years as Fed chair.

“I think the Fed can calibrate things carefully and gradually in a way not to push us into a recession,’ said Kathy Bostjancic, chief US financial economist at Oxford Economics, a global forecasting and analysis firm. “But it is a challenge because historically we all know the Federal Reserve and other central banks have not been all that successful in navigating a soft landing for the economy.”

“The only reason we have this surge in inflation now is we got hit with a shock, an unprecedented kind of shock,” Baumohl said. “In some ways, you can consider it like an earthquake that happened in 2020 and we’ve had these aftershocks as a result of the additional variants.”

He expects inflation to peak in the first three months of this year as economic growth slows — but doesn’t stall — with less federal stimulus spending and as supply chain constraints ease. That would allow the Fed to pull back slightly on interest rate hikes and keep the economy out of recession. Powell and Fed officials will have to move cautiously and not overreact to inflation, Baumohl said.

The Fed is also taking action at a time when its influence on the economy may be weaker than in the past. The pandemic has distorted the economy to the point that the Fed’s conventional tools, like interest rate hikes, are limited in their effectiveness, said Stephanie Kelton, an economics and public policy professor at Stony Brook University. That constrains the Fed in bringing down inflation but also makes it harder for Fed intervention to cause a recession, she said.

“It’s not really inflation. … What we’re suffering from is price instability, which is something different,” he said. “It’s going to take time [to stabilize] because this is global and the disruptions to supply are a global phenomenon.”

Geopolitical risks
As Russia seeks to take advantage of political changes and/or instability in countries like the UK and Germany, the imposition of sanctions against Russia would likely spark a further increase in energy prices – and hence inflation. And one can assume that China is closely monitoring developments in Europe and considering its options for taking advantage of the crisis in Ukraine.

Are supply chain issues really transitory?
Last year the mantra was that inflation, in large part because of supply chain issues that were deemed to be temporary. But here we are in 2022 and supermarket shelves are still short of many items. And in typical investment manner, the timeframe for when the supply chain issues will get fixed keeps getting pushed out, from the second half of 2021 to the first half of 2022 and now maybe the second half of the year.

Will the Fed be successful or are mortgage rates headed to 4%?
The answer may be both.
It is important to understand that the Fed controls short-term rates and that mortgage rates are based upon the yield of the 10-year Treasury, where the yield is set by market demand, I have written extensively on the connection between the two rates and will write another report soon.
I have been forecasting – guessing – that mortgage rates will reach 4% this year as I expect that interest rates will need to be raised aggressively to ward off stubbornly persistent inflation. But if the result is indeed a recession later this year then interest rates may ease back later.

And read these recent articles:
Naples Year End Market Report by Location and Property Type
Bonita Springs 2021 Year End Market Report
Guide to Buying and Selling in Southwest Florida

If you – or somebody you know – are considering buying or selling a home and have questions about the market and/or current home prices, please contact me on 617.834.8205 or

Andrew Oliver, M.B.E., M.B.A.
Real Estate Advisor

800 Laurel Oak Drive, Suite 400, Naples, FL 34108
m: 617.834.8205

Licensed in Massachusetts