For the Fed, doing nothing is the greater risk

Given the signals coming from the Federal Reserve lately, one might think its battle with inflation will soon be coming to an end. Markets expect — and multiple officials have hinted — that the central bank will pause interest-rate increases at this week’s policy meeting, to ensure it doesn’t tighten excessively.

It’s a mistake in the making. Backing off too soon remains the far greater risk.

Advocates of a pause argue that the Fed’s tightening is already bearing results. The steepest series of interest-rate increases in more than four decades, from near zero to more than 5 percent in less than 14 months, has taken down several poorly prepared regional banks, which might in turn curtail credit and economic growth. Also, some inflation indicators have been easing: Goods prices have settled down after spiking during the pandemic; decelerating rents and home values should soon flow through to official measures.

This progress, though, is no assurance of success. The banking turmoil has so far affected only a small fraction of the industry, and alternative lenders are eager to fill any breach — hardly the kind of credit retrenchment required to have much aggregate effect. At 3.7 percent, the unemployment rate remains near its lowest point since 1970, and below the level that Fed officials consider sustainable without overheating the economy. No wonder some measures of annual wage growth remain as high as 6 percent, and core consumer-price inflation — at 5.3 percent in May — far exceeds the Fed’s 2 percent target. If one adjusts for that level of inflation, it’s not even clear that short-term interest rates are high enough to restrict growth.

True, monetary policy operates with a lag. There’s a risk that unrelenting interest-rate increases now will eventually trigger a deeper recession than needed to get prices under control, inflicting unnecessary suffering. But the alternative is far worse. If the Fed allows inflation expectations to become entrenched, it will ultimately have to take rates much higher — and cause much greater hardship — to compensate and restore its credibility. Better to get it right the first time, even if imperfectly.