WASHINGTON — Two meetings Wednesday in the nation’s capital, less than a mile apart, could prove pivotal in determining whether the US economy finesses a soft landing this year amid a struggle with high inflation or plunges into a recession.
At one, officials of the Federal Reserve, bolstered by encouraging economic data, are expected to announce another easing of the interest rate hikes they first instituted nearly a year ago to bring soaring prices under control.
But the second one could undermine all of the Fed’s efforts, as President Biden and House Speaker Kevin McCarthy are scheduled to meet to discuss a looming crisis with the nation’s $31.4 trillion debt limit.
This is the first major confrontation with the White House since Republicans took control of the House. GOP leaders have insisted on major spending cuts in exchange for raising the debt limit, which the United States has already hit, and a failure to reach a deal could lead to a first-ever government default and set off an economic calamity.
“We’d be lucky if we only get off with a mild catastrophe,” said William Spriggs, an economics professor at Howard University and chief economist to the AFL-CIO organized labor federation.
The Fed aggressively began raising its benchmark interest rate last March to rein in inflation that was headed toward a four-decade high, driven in part by shortages of goods during the pandemic, increased spending fueled by COVID-19 rescue spending, and skyrocketing energy prices caused by the Ukraine war.
Because they make it more expensive for consumers and businesses to borrow, Fed rate hikes can trigger a recession by cutting into demand too much. But in the past few months, inflation has moderated as consumer spending has slowed, even though the economy continues to expand and produce solid job growth. That’s led to some rising optimism that the United States might be able to avoid a recession.
The US economy grew at a 2.9 percent annual rate in the last three months of 2022. That was down from 3.2 percent in the third quarter but still a long way from the negative growth that would come with a recession. The International Monetary Fund this week boosted its projection for US economic growth this year to 1.4 percent, not strong but better than the recession-territory 0.4 percent figure it had forecast last fall.
“There is a narrow path that allows the US economy to escape a recession altogether, or if it has a recession, that recession would be relatively shallow,” Pierre-Olivier Gourinchas, the IMF’s top economist, told reporters.
Many economists still aren’t sold on the United States skirting a recession this year, what the Fed calls a “soft landing,” but acknowledge the odds have improved.
“The economy has so far shown pretty good resilience to interest rate hikes from the Fed,” said Michael Gapen, head of US economics at Bank of America. “Maybe the risk of a recession has gone down a little, but I think it’s too early to declare all clear.”
Fed officials have expressed the same view, vowing to stay the course until they’re convinced inflation is solidly on a downward track. Noting that inflation improved for a period in 2021 before shooting back up again, Fed governor Christopher J. Waller declared in a recent speech that, “We do not want to be head-faked.”
But after aggressively raising their key interest rate by three-quarters of a percentage point in four consecutive meetings, Fed officials in December hiked the rate just one-half a percentage point. The rate now stands at a range between 4.25 percent and 4.5 percent after beginning 2022 at near zero.
Fed officials projected in December that they would ultimately push rates to a little over 5 percent, so they don’t have much further to go. And with the consumer price index declining from a 9.1 percent in June to 6.5 percent in December, analysts and investors expect a rate hike of just one-quarter of a percentage point on Wednesday.
But getting annual inflation down to the Fed’s target of 2 percent will be extremely difficult without causing a recession, said Kathy Bostjancic, chief economist at Nationwide, an insurance and financial services company.
“The economy is definitely decelerating,” she said. “They’re trying to achieve a soft landing. . . . I think it’s incredibly tough to navigate that.”
Bostjancic put the odds of a recession this year at 70 percent. Spriggs also expressed fear the economy was headed in the wrong direction and said the Fed shouldn’t be raising rates again on Wednesday.
“They need to see how the economy responds to these interest rates,” he said. “There’s a huge lag to their policy.”
With the economic outlook already uncertain, a stalemate over the debt limit could be the tipping point. A failure by Congress to raise the debt limit in the coming months, causing a first-ever federal government default, would roil financial markets and shake already precarious consumer confidence, pushing the nation into a recession, economists said.
“If they actually default, I think it would be very serious and destructive,” said Donald Kohn, a senior fellow at the Brookings Institution think tank who was Fed vice chair from 2006-10. “Even if it was solved in a very few days, it would add to the sense that our very fraught political environment was having an adverse effect on the ability of the government to conduct business in a sensible way.”
Amid those concerns, Biden invited McCarthy to the White House to discuss the debt limit dispute. Biden has said he won’t negotiate over raising the limit, which simply allows the government to pay for spending already authorized by Congress. Many Republicans voted to raise the debt limit three times under former president Donald Trump, when the nation’s total debt also increased sharply.
But exchanges between the the White House and Capitol Hill left little hope their first encounter would produce much progress.
“Raising the debt limit is not a negotiation; it is an obligation of this country and its leaders to avoid economic chaos,” two top White House officials, Brian Deese, director of the National Economic Council, and Shalanda Young, director of the Office of Management and Budget, said in a memo released Tuesday.
They said Biden would ask McCarthy to commit to avoiding a default and a date by which House Republicans will release a budget showing their proposed cuts. McCarthy has said that there won’t be a default and that Republicans would not touch Social Security and Medicare. But he has said all other spending is on the table to reduce the growth of the national debt.
“I’m not interested in political games,” McCarthy tweeted Tuesday in response to the memo. “I’m coming to negotiate for the American people.”
If Biden and McCarthy can’t work out a solution, the economy would suffer.
“The economy is fundamentally sound,” Spriggs said. “The threats are the Fed being stupid [and continuing to raise rates] and the House Republicans doing something unbelievably irresponsible.”
Jim Puzzanghera can be reached at jim.puzzanghera@globe.com. Follow him on Twitter: @JimPuzzanghera.
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