Written by Howard Schneider

NEW ORLEANS (Reuters) – The Federal Reserve’s efforts to shock the economy back to the low inflation rates in its early days, making it difficult for the US central bank to avoid hitting interest rates higher than needed, a senior US economic advisor said. The Obama White House said after a new review of Fed policy since World War II.

The Fed raised its target policy rate by more than 4 percentage points in the past year, and “we are now entering the window where the effects may start to be noticed,” Christina Romer, professor of economics at the University of California, Berkeley, and chair of the White House Council of Economic Advisers (CEA) from 2009 to 2010, in front of a national gathering of economists late Saturday.

“Because of the delays involved, policymakers will face a very difficult decision about when to stop or reverse interest rate increases,” Romer said in a keynote address to the American Economic Association’s annual meeting in New Orleans.

“Policy makers will need to go back before the problem is fully resolved if they want to bring down inflation without causing more pain than necessary,” she said.

Federal Reserve officials have acknowledged how difficult it is to judge how high and how long to raise interest rates, and have scaled back the pace of increases in borrowing costs to try to avoid missteps.

Minutes of the Fed’s last policy meeting in December showed central banks grappling with risks, while economists see a high probability that an interest rate hike could lead to a US recession next year.

Policy shock

Roemer, the outgoing president of the AEA, is an expert on the causes and recovery of the Great Depression of the 1930s and has argued as CEA president for the fiscal response to the 2007-2009 recession to be far greater than was approved. She teamed up with Berkeley economist David Romer, her husband, to extract transcripts of a Fed meeting and minutes from the 1940s to review US central bank policy.

They identified 10 cases when the Fed purposely tried to change the course of economic growth, in all but one of the cases to try to reduce inflation, which it felt was too high.

Since the transcripts are only available up to 2016, they relied on the minutes alone of recent years and concluded that the current tightening cycle is the eleventh monetary policy “shock”.

These events contrast with other Fed decisions on interest rates that aim to stay in sync with the business cycle or respond to external economic events, such as the housing market crash and the onset of a recession in 2007. Isolating the shocks, she said, allows for a clearer view of how reserve rate increases will affect Federal on economic production and employment, and in what time frame.

It found that as interest rates rose, overall output began to slow about six months after the policy shock began, and after nine quarters it was 4.5% lower than it would otherwise have been. The unemployment rate begins to rise after about five months and rises by an average of 1.6 percentage points after 27 months, with the effect fading after five years.

The Fed began raising rates last March, but accelerated the rate hikes in June to one similar to the rapid tightening former Fed Chairman Paul Volcker used in the late 1970s and early 1980s. The central bank’s policy rate now stands in a range of 4.25%-4.50% and officials are widely expected to raise it by another quarter percentage point on Jan-Feb 31. One meeting, with an eye on driving it above 5% in the coming months.