What if the Fed can't tame inflation?

New York(CNN Business) To badly misquote John Lennon: Everybody's talking about inflation, stagflation, capitulation, globalization, stagnation, this-ation, that-ation, -ation, -ation, -ation. All we are saying is please make it end. 

Americans view inflation, which is near 40-year highs, as the top problem facing the country today by a very wide margin. No other concern comes close. 

Members of the Federal Reserve, the central bank tasked with deflating inflation from 8.3% to its goal of around 2%, are now raising interest rates in an attempt to cool the economy. 

A policy-induced economic slowdown is a painful endeavor: Markets briefly crashed into bear territory Friday and many analysts believe a recession is unavoidable. 

That's okay: Medicine doesn't have to go down easy if it works fast and it works well. But inflation rates have been increasing sharply since August 2021 and have been out of the normal 2%-to-4% range for a full year. Now a growing distrust in the Fed's capabilities and a belief that they've become entangled in a policy error has raised the question: What happens if the Fed can't get inflation under control and we're stuck in a long term cycle of elevated inflation and recession? 

Why it matters: Record high inflation has created a multi-layered crisis. At its core, it represents a political crisis for the Democrats defending their very tight majority in Congress, and a crisis of faith for economists who misjudged the persistence and significance of rising prices as a "transitory" blip and may have missed their chance to get ahead of the curve. 

Most importantly, it's a crisis for the American wallet. The average price for a gallon of gas has surpassed $4 in all 50 states for the first time ever. Food prices were 9.4% higher in April 2022 than in April 2021, the largest annual increase in 41 years. Americans have seemingly shifted into survival mode: Target and Walmart reported last week that discretionary spending is easing as customers struggle to cover basics like food, fuel and shelter. 

This is different: The Federal Reserve is likely borrowing ideas from its 1994 playbook, the last time the central bank successfully raised interest rates and executed a soft landing. But things are different now. We're dealing with a serious labor shortage caused by baby boomers ready to exit the workforce, a significant pandemic-reduced labor participation rate and a productivity slowdown. Globalization is in retreat as the pandemic and war in Ukraine have led to significant energy price shocks and supply chain disruptions.

"These are uncharted waters for all of us," said Liz Young, head of investment strategy at SoFi. "Inflation hasn't been this high since the year I was born." The economy will recover, she said, but it's going to be a "slow burn." Markets will continue to tumble, and prices will remain elevated for a while, she added: "I think we might have to stay there for a little while. I don't know that we're going to bounce back out of it very quickly."

Trust in the central bank is also lagging. Investors are calling for a three-quarter-point rate hike at the conclusion of the Fed's June meeting, despite Fed Chair Jerome Powell's assurances that an increase that high isn't on the table. Even former Fed Chair Ben Bernanke said the central bank had erred in its approach to addressing 40-year-high inflation.

Part of the lack of confidence stems from the increase in broad and fast social media and communications outlets --— and has nothing to do with what's going on at the central bank, said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. A continuous real-time feed of news and analysts makes it easier to judge the Fed's actions and not their outcomes.

"You know them so much better now," said Silverblatt. "You see all of the nooks and crannies." 

Timing is everything: Inflation rates don't always come down. Just look at the 1970s when the US economy suffered three recessions during which the underlying inflation problem never went away. 

"Stagflation is probably the worst word of vocabulary for financial markets because it's the worst of both worlds. Inflation stays high and the economy slows," said Leo Grohowski, chief investment officer at BNY Mellon Wealth Management. "I think we're getting a whiff of stagflation now." 

But the ghost of the 1970s lingers on in all Fed governors' minds, and they've said they'll ratchet up their hawkishness — no matter what it means for markets and the economy. 

"The process of getting inflation down to 2% will also include some pain, but ultimately the most painful thing would be if we were to fail to deal with it and inflation were to get entrenched in the economy at high levels, and we know what that's like," Powell said in a recent Marketplace interview.  

Grohowski says he sees inflation sticking for the remainder of this year and some of next, but that it is not yet entrenched in the economy and will come down by 2023. 

Still, sentiment is not the same for investors and consumers. Among economists and analysts, said Grohowski, "there's the expectation that there will be some relief and that we're most likely right now living through peak inflation." But consumers are "worried that today's inflation rates are going to continue for longer. 

They may not be wrong. While prices for certain goods will fall quickly, energy and housing prices will likely remain high for some time, according to the Fed. 

We don't think inflation is entrenched," said Grohowski. "But we admit that there is concern, because parts of inflation are stickier than most economists and even the Fed expected."

Davos is back and the world has changed

The World Economic Forum — which famously combines high-minded panels with flashy parties — is back in person in Davos, Switzerland, for the first time in two years. The conference aims to bring important people together to tackle pressing issues like inequality, climate change, the future of technology and geopolitical conflict. But the logic behind inviting some of the wealthiest people on Earth to solve these problems from a resort town looks even shakier these days.

Billionaires added $5 trillion to their fortunes during the pandemic, according to a report from Oxfam published in January. The world's richest 10 men saw their collective wealth more than double. Meanwhile, tens of millions more people around the world were pushed into extreme poverty.

The event takes place against the backdrop of the worst cost-of-living crisis in decades in both developed and many developing economies. Soaring food and fuel prices are already causing hunger and hardship, fanning instability, triggering protests and emboldening political insurgents.

The main event is likely to be a speech on Monday by Ukrainian President Volodymyr Zelensky, who is expected to participate via video conference. German Chancellor Olaf Scholz and European Commission President Ursula von der Leyen are also scheduled to deliver addresses later in the week, which will be scrutinized as EU countries struggle to agree on a formal oil embargo against Russia.

Up next

Monday: Federal Reserve Bank of Kansas City President Esther George speaks; Earnings from Zoom Video Communications, 

Tuesday: April new home sales; Earnings from Intuit, AutoZone, Best Buy, Toll Brothers, Petco and Nordstrom

Wednesday: April core durable goods orders, FOMC minutes, weekly crude oil inventories; Earnings from NVIDIA Corporation, Williams-Sonoma and Dick's Sporting Goods

Thursday: Q1 GDP (Second Estimate), Initial jobless claims, April pending home sales; Earnings from Alibaba, Costco, Dollar General and Dollar Tree

Friday: Federal Reserve Bank of St. Louis President and FOMC voting member James Bullard speaks