Editor’s Note: Steven Kamin is a senior fellow at the American Enterprise Institute (AEI), where he studies international macroeconomic and financial issues. He served as director of the international finance division of the Federal Reserve from 2011 to 2020. The opinions expressed in this commentary are his own. View more opinion on CNN.

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The Federal Reserve has done a reasonable job of managing the surge in consumer price inflation over the past year and a half. Having peaked at 9.1% year-over-year in June, the Consumer Price Index declined in November to 7.1% year-over-year, the slowest pace since December 2021. But with price growth still drastically above normal levels, labor markets quite tight, and household spending resilient, the Fed’s challenges are far from over. As we move into 2023, inflation will continue to be a key risk to both the US and foreign economies.

Steven Kamin

There’s no doubt the Federal Reserve was late in responding to inflation. It only started to raise interest rates in March of this year, well after every measure of inflation the Fed follows had doubled or even tripled its 2% target. And there was a good chance that, in its haste to catch up to where it needed to be, its rapid interest rate hikes would trigger turmoil in financial markets and tank the economy.

But, at least so far, the central bank has managed to cool overheated financial markets, slow growth in sectors such as housing, that are sensitive to interest rates, and contain inflation expectations without either pushing the economy into a recession or breaking the financial system.

By the same token, the spillovers of the Fed’s moves to the rest of the world have been manageable. The dollar’s central role in the international financial system means the effects of US monetary policy don’t stop at our borders — they reverberate throughout the global economy.

Observers have complained that the Fed’s aggressive rate hikes and the associated rise in the dollar threaten emerging market economies with default and economies throughout the world with higher inflation as a result of higher import costs. However, these concerns are overstated. Many of our major trading partners are indeed facing severe problems, but these are due more to elevated oil and food prices, Russia’s invasion of Ukraine, and China’s struggles with “zero-Covid” than to Fed policy.

Notably, most emerging market economies, which tend to be especially sensitive to US monetary conditions, have been weathering the rise in interest rates and in the dollar reasonably well. Especially fragile economies, such as Sri Lanka, Pakistan and Argentina, are experiencing dire debt problems, but these largely reflect their own fundamental imbalances.

Unfortunately, this story is far from over. US inflation has moved down a bit since its peak earlier this summer, but this importantly reflects declines in energy prices. So-called “core” inflation, which excludes volatile energy and food prices and thus provides a more reliable reading on price trends, has largely moved sideways over the course of this year.

The Fed is set to raise interest rates a bit further over its next few meetings -— probably to around 5% — and most likely won’t reverse its rate hikes until it sees substantial and sustained declines in core inflation.

The base-case scenario for most forecasters is gloomy, but not catastrophic: US inflation moves down gradually over the next year, driven by supply-chain disruptions easing, energy and other commodity prices falling and aggregate demand softening. High interest rates help push the US economy into a mild, short-lived recession, cutting jobs and further easing price pressures. In response, the Fed starts cutting interest rates by late 2023 or early 2024, which will allow the US economy to recover and the rest of the world to see renewed economic growth.

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    There is a much more worrisome scenario, however, in which US inflation remains stubbornly high, perhaps because the combination of continued tight labor markets and elevated living costs fuel persistent rapid wage growth. Such a wage-price spiral would pose a difficult conflict between the policy needs of the US economy and those of the rest of the world. Further increases in interest rates would be essential to bring down US inflation and inflation expectations. But at a time when many of our trading partners were mired in recession, further policy tightening could create grave problems abroad: substantial job losses, widespread defaults and disruptions in international financial markets.

    In those circumstances, we could expect to hear calls for the Fed to abandon its tightening policy to reduce damage to the global economy. But such calls would be misguided. In the longer run, a sustained reduction in inflation is not only in the interests of the United States. Because of the global importance of the US economy and the dollar’s preeminence, a series of “stop-go” monetary policies — tightening to contain inflation, then loosening to prevent recession and repeat — would be nearly as damaging to the world economy as it would be domestically. Prematurely easing monetary policy would merely postpone the pain and require even greater tightening later on. Accordingly, it is critical for all concerned, both here and abroad, that the Fed succeed in returning inflation and inflation expectations to their pre-surge levels and keep them there in the long run.