With the US central bank having already dug itself a deep hole, it is no longer crystal clear what the right policy step should be now.
With several hotter-than-expected inflation numbers coming after two successive downshifts in interest-rate increases, an interesting debate is raging as to what the Federal Reserve should do next: go back to a larger rate increase or maintain a slower pace but keep higher rates for longer.
At least three Fed officials have already publicly signalled their openness to a 50-basis-point increase afterOthers have yet to weigh in and may well be on the fence because of the counterargument that it is too early to evaluate the full impact of what, after a hesitant start, was one of the most front-loaded rate-increase cycles in decades.
But it risks giving inflation even more time to embed more deeply into the economic system; and it does mean that the Fed may have to continue raising rates into a weak and weakening economy.Interestingly, the ultimate peak rate migrates higher under both policy alternatives. But the time at this peak rate is presumed to be longer for the slower journey.
These multiple dilemmas illustrate a much bigger, longer-lasting and consequential policy challenge – that of operating far from the set of first best policy responses.
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