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Fed officials start to embrace the possibility of recession

Policymakers at the Federal Reserve are beginning to entertain the possibility of recession, as high inflation pushes the central bank to raise interest rates at the fastest pace in decades.

“It’s certainly a possibility,” Fed Chairman Jerome Powell told the Senate Banking Committee on Wednesday when asked about the chance of a recession.

Powell clarified: “It’s not our intended outcome.”

The Fed chief's remarks on Wednesday stand in contrast to his commentary from early May, when the Fed chair asserted that, “nothing about [the economy] suggests that it’s close to, or vulnerable to, a recession.”

The change in tone underscores seeming concern within the Fed that the cost of lowering inflation may be a drop-off in economic growth and potential job losses.

“We could have a couple of negative quarters" of economic growth, Philadelphia Fed President Patrick Harker told Yahoo Finance in an interview Wednesday.

The definition of a “recession” is commonly referred to by investors as two back-to-back quarters of negative economic growth. The first quarter of 2022 already saw a real GDP contraction of 1.5% on an annualized basis. An initial reading on second quarter growth is due at the end of July.

The National Bureau of Economic Research, which is in charge of “dating” recessions, clarifies that they look beyond real GDP figures when declaring a recession. The NBER looks at real income, employment, among other economic variables.

“Our goal is to achieve 2% inflation while still keeping the labor market strong,” Powell told Congress on Wednesday.

Federal Reserve Chair Jerome Powell testifies before a Senate Banking, Housing, and Urban Affairs Committee hearing on the
Federal Reserve Chair Jerome Powell testifies before a Senate Banking, Housing, and Urban Affairs Committee hearing on the "Semiannual Monetary Policy Report to the Congress", on Capitol Hill in Washington, D.C., U.S., June 22, 2022. REUTERS/Elizabeth Frantz (Elizabeth Frantz / reuters)

No 'hard landing'

Although the Fed is embracing the possibility of a recession, the Fed is not expecting a "hard landing," or an abrupt turn in the economy.

On Wednesday, Harker said an unemployment rate “significantly” higher than 4% would signal the so-called “hard landing.” The unemployment rate was at a relatively low 3.6% as of May.

In economic projections released last week, the median member of the Fed’s policy-setting committee forecast that the central bank could lower inflation to a 2.2% rate through 2024 with the unemployment rate only rising to 4.1%.

Speaking with reporters last week, Powell said the Fed is "not trying to induce a recession," adding that its policy "[does not] seek to put people out of work."

At the center of the Fed’s projections: raising short-term interest rates to about 3.8% next year, which would represent multiple rate hikes from the current setting of about 1.6%.

By making it more expensive to borrow, the Fed hopes to moderate demand. Harker said Wednesday that he is beginning to see some signs of demand softening in the economy.

Moreover, Powell told lawmakers on Wednesday Fed policy may not abruptly curb demand and push companies to trim their workforces as activity grinds to a halt. "I am trying to lower demand growth, we don’t know that demand actually has to go down, which would be a recession," Powell said.

Richmond Fed President Tom Barkin similarly argued on Tuesday that a slowdown is possible without two back-to-back-quarters of negative GDP growth.

“It doesn’t have to require a calamitous decline in activity,” Barkin said, adding that positive developments on the war in Ukraine and shutdowns in China could lift supply chain snags and alleviate inflationary pressures.

But with the Fed already moving last week to raise rates by 0.75%, the largest move it has made since 1994, concerns are nonetheless building up that a Fed hike into a recession is becoming more likely, as 8 of the last 11 tightening cycles from the Fed have led to some recession.

Still, some Fed officials aren't convinced history is much of a guide in the current circumstances.

As Harker told Yahoo Finance on Wednesday: "This is unique, but I think we have to recognize that and execute policy based on what we’re seeing, not based on some historical example."

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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