It's a Long, Bumpy Road Back to 2% Inflation

The Federal Reserve has finally started to get real. It increased the policy rate target Wednesday by 50 basis points. More rate hikes are expected as the Fed tries to bring down inflation. But will this be enough? Technically, the Fed is still in accommodative mode; rates are so low they're helping make inflation worse. But if the Fed increases rates too much and too fast it risks a recession. Though it may need to create a recession to bring inflation back down. There are no easy choices.

In the second part of my conversation with Dartmouth economics professor and former Fed economist Andrew Levin, we discuss what the Fed is facing in the next few years, and what it needs to do to bring inflation back down. The conversation has been edited for length and clarity.

Allison Schrager: Do you think the Fed did the right thing by increasing the interest rate by 50 basis points?

Andrew Levin: Unfortunately, the Fed is still not following the basic principles of sound monetary policy that it has laid out on its own website.

What really matters to the economy is the inflation-adjusted interest rate, which is the rate minus inflation. At this stage getting to a neutral rate, where it is no longer pushing inflation even higher, is the top priority. The monetary policy stance is neutral when the federal funds rate is just a bit higher than the underlying trend of inflation.

Right now the underlying level of inflation is running at about 5% once you take out transitory factors, so the inflation-adjusted interest rate is deeply negative (about -4%). Getting to neutral, as Fed Chairman Jerome Powell said himself Wednesday, is still a long way off. He appeared to take the possibility of a 75-basis-point increase off the table, preferring to stick with smaller hikes in coming months. And that means the Fed could still be adding fuel to the inflationary inferno, even by the end of this year.