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Federal Reserve has a difficult needle to thread with interest rate hikes, says Bradley economics professor

Nam Y. Huh/AP
A hiring sign is displayed at a restaurant in Morton Grove, Ill., Thursday, April 28, 2022. America’s employers added 428,000 jobs in April, extending a streak of solid hiring that has defied punishing inflation, chronic supply shortages, the Russian war against Ukraine and much higher borrowing costs. (AP Photo/Nam Y. Huh)

The Federal Reserve is raising interest rates as an inflationary countermeasure.

Rates were hiked by half a percentage point earlier this week, with more increases expected later this year.

The right balance and timing with interest rate increases can cool down the overheated economy. But too much action could drive the nation into a recession.

"We've almost never seen inflation this high in the past before," said Colin Corbett, an assistant economics professor at Bradley University. "So it's a little hard to draw from precedent. But most times when the Fed has had to crank up interest rates pretty quickly, that definitely has the potential of triggering a recession."

Bradley University
Colin Corbett

Corbett said there's some merit to recent criticism the Fed hasn't done enough to curtail inflation, but he said they're also walking a difficult tightrope in the absence of executive and legislative branch action to reduce inflation.

The inflationary panic of the late 1970s isn't necessarily a good analog for what's happening in 2022, Corbett said. He said back then, inflation was "baked" into the economy in a way it's not now.

"Back in the '70s, inflation was just part of the economy, and trying to break that was really hard, and took sort of almost purposely crashing the economy," he said, referring to the recession which followed the Fed's interest rate hikes to cool down inflation several decades ago. "But that is not the intention nowadays."

Corbett said a key effect of rising interest rates is lower investment in long-term goods, particularly housing. He said it may help prospective homebuyers if that red-hot market simmers down a bit, but he said too much pullback on investment would have a negative impact on the economy.

He said it will also be worth monitoring external factors, such as the war in Ukraine and the COVID-19 lockdowns in China.

"Hopefully, the rest of our economy being strong will sort of weather those, but it's possible that that will be the one thing that tilts the balance in one direction or the other," Corbett said.

In many ways, Corbett said the COVID-19 pandemic may end up being the watershed economic realignment of this generation, similar to how the 2007 housing market crash brought on the 2008 Great Recession.

In the wake of the 2008 recession, Corbett said many people took on low-wage service-sector jobs, in the absence of better opportunities in the employment market. COVID-19 had the opposite effect, he said.

"The question is in the what the economy looks like now, with labor being much more scarce, maybe the restaurant business model is no longer quite as viable," he said, referencing one sector struggling with worker shortages.

Corbett said people in the current job market are shifting to the work they want to do or are most skilled at performing. He said that might not be good news for employers trying to fill less desirable jobs.

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Tim is the News Director at WCBU Peoria Public Radio.