Edward Price, a former U.K. economic official and now a political economy teacher at New York University’s Center for Global Affairs, looks at the dangerous path the Federal Reserve has taken to deflate the U.S. economy without disrupting markets.

Not long ago, the Fed was worried. Why can’t it generate a measly 2% inflation?

In fact, in the summer of 2020, the world’s most important central bank was so concerned that it launched a framework designed to stimulate price pressures and stimulate job creation. At the core is the Flexible Average Inflation Targeting, or FAIT. FAIT would give officials leeway to allow the economy to overheat, with inflation surging past the 2% target for an unspecified but limited period. As a result, the U.S. labor market will tighten. Meanwhile, the Fed’s ability to fight inflation remains intact.

The theory argues that the past decade has shown that the U.S. economy can tolerate higher employment rates without the risk of a wage and price spiral. So as the pandemic shut down companies and lost jobs, the Fed did the obvious. It began to look for inflation, including cutting interest rates and injecting unprecedented liquidity into financial markets.

Oops.

Now inflation is coming. Throughout the first half of 2021, Fed officials promised it would be temporary. But the consumer price index (CPI) in October was 6.2%. This inflation appears to be sticky and well above the Fed’s expectations. So, it’s changing direction.Indicated early in the pandemic that interest rates will until the end of 2023, released the minutes of the December FOMC vote last week indicated it was considering a rate hike in the first half of the year.

It all means the U.S. central bank is turning a corner. But what strategies will bury price pressures?

What everyone wants to see is a U-turn, a smooth and controlled change of orientation. In this case, the Fed will go head-to-head, signal it carefully, and turn its hood seamlessly. Everyone will be happy. The FOMC will say that it has given a lot of notice since the December minutes. Investors can methodically adjust their portfolios. The wine glass will go. But no one’s drink will spill.

suspect. The minutes have already sparked a sell-off in tech stocks. Actual rate hikes are sure to spook markets as they are lured by a weak federal funds rate and ample liquidity.

So the Fed is in trouble. Three fates are calling. If you’re lucky, inflation is temporary and prices are stable at 2%. With no luck, inflation is entrenched well above 2%. If you are very unlucky, the price will drop and the U-turn can become an epic mistake. quite binding. What happens, however, depends in part on what the Fed does. A small rate hike to combat non-transitory inflation could dampen inflation, leading to temporary inflation. At this point, the FAIT case looks plausible again. But that’s too tight and too uncertain for a complete U-turn.

So, we might see a K-turn, an awkward three-point maneuver. There will be stops and there will be starts. Things won’t be smooth sailing. The wheels will vibrate. All drinks shake. Some investors will get caught, but we will avoid a major panic.

Unfortunately, there is a problem here too. Foggy windshield. The expansionary fiscal policy of the United States will have unknown consequences. Who knows what the supply chain will do in 2022? Some expect these barriers to persist throughout the year. Others expect the stress to ease. Either way, the FOMC must act aggressively to counteract the effects of stubborn bottlenecks. Also, many investors ignore the fact that interest rates are well below where inflation hovered around 5% last time. As a result, the size and pace of cuts in market pricing may be too insignificant to counter truly stubborn price pressures. That’s the point. If the Fed can’t see the future and really can’t resist raising rates, it will likely lose control over how far and how fast those rate hikes must go.

This brings us to a third option: fast J-turns. This action is rare. Often reserved for the military, it causes the vehicle to rotate sharply in the opposite direction. The result is the power to rock the skull. Yes, it’s fast. Yes, it works. But for passengers, it’s no fun. Everyone’s drink is spilled. Of course, we are those passengers.

Addressing inflation like this would raise profound questions about the viability of FAIT. In fact, that would put a question mark on the 2% target that has been the hallmark of central bank frameworks everywhere for decades. The concept behind an independent central bank looks far from sound. In fact, they look very uncomfortable.

The J-turn is also scary. Lurking ahead is the goblin of the financial crisis. Central banks are unable to reconcile tightening to meet economic needs and continue to ease for broader financial stability. Ultra-low interest rates risk financial bubbles and eventual turmoil. But ultra-high interest rates could burst these bubbles in catastrophic fashion. After years of quantitative easing, a dissonance between the money demand of the economy and that of the market is inevitable.

All in all, the surge in US prices has revealed the inherent flaws of open FAIT. Now, the Fed will have a hard time getting out of Inflationsville without going through a meltdown. Exiting years of accommodation will create conditions that require new accommodation. Normalization will never be anything.

Please fasten your seat belt. Be sure to grab these drinks.