Significantly higher interest rates and slower demand also mean potentially causing a recession, which would cause unemployment disproportionately among the poor. How severe such a housing-market crash and labor-market downturn will be after the Fed starts raising rates will ultimately answer the question of whether the Fed can reasonably engineer a “soft landing.” History, though, is not on the Fed’s side. Almost every tightening cycle in the post-war era in response to inflation has ended in recession.
All U.S. recessions in the post-war era have been the result of either Fed interest-rate hikes, financial-asset bubbles bursting (think the early 2000s tech bubble and late 2000s housing bubble) or a pandemic (as in 2020). Recessions caused by the Fed correcting its past mistakes are the most common type of recession in the post-war time series, although we haven’t seen such a recession since the early 1990s.
The net upshot of the Fed’s 2021 monetary-policy largesse is that we now have both an inflation and an asset-price inflation problem. At 8.3 percent, consumer-price inflation is now running at its highest rate in the past 40 years. At the same time, by the end of last year, equity valuations had reached nosebleed levels experienced only once before in the past 100 years, while house prices have exceeded those from the eve of the 2006 housing-market bust — even in inflation-adjusted terms.
To deal with the inflation problem, the Fed is now slamming on the monetary brakes hard. It is doing so by raising interest rates in 50 basis point rather than the more-normal 25 basis-point steps. It is also proposing that, beginning in August, it will withdraw $95 billion a month in liquidity from the markets by not rolling over its maturing bond holdings.