- The Federal Reserve approved raising interest rates to fight soaring inflation.
- The US faces the fastest and largest rate increases in years.
- No guarantee inflation will be tamed but the economy may stall out.
Inflation Drives Need for Rate Increase
The Federal Reserve approved the first interest rate hike in more than three years. Six more rate hikes are scheduled for this year alone. The Fed says the aim of rate hikes is to tame runaway inflation.
Price increases are at their fastest 12-month pace in 40 years. The increases are made worse by clogged supply chains unable to meet renewed demand. Prices are up 7.9% year-over-year according to the Consumer Price Index. Gasoline alone has risen 38% in the 12-month period. 1
The Ukraine war has just made inflation worse. The conflict spiked oil prices – which turbocharges inflation. The Russian invasion is going to have a negative impact on the US economy. The Fed stated, “The implications for the U.S. economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.” 2
When the Fed raises interest rates, the effects ripple throughout the economy. Mortgages, auto loans, and credit card rates become more expensive for consumers. Businesses also pay more to borrow the money they need to fund their operations or expand. That tends to make both consumers and businesses spend less. Which may then cool the economy and, hopefully, drive down the prices of goods and services.
The Fed acknowledges they missed the mark by calling inflation ‘transitory’ in December. Their original 2% target now looks ridiculous. They now estimate dramatically higher inflation and much slower GDP growth. Kiplinger’s predicts inflation will soon spike close to 10%. 3
How High and How Fast Rates Are Going Up
The policy making Federal Open Market Committee will raise rates by a quarter percentage point. This puts the rate in a range between .25% and .50%.
They are scheduled to raise rates at each of the six remaining meetings this year. And then three more hikes in 2023. And theoretically, no hikes in 2024. The Federal Reserve hopes by raising the rates incrementally, they won’t stall the economy.
Fed policy set the groundwork for this out-of-control inflation. Inflation was superheated by unprecedented levels of fiscal and monetary stimulus – more than $10 trillion worth.
Also, the Fed tried a new inflation policy in September 2020. They slashed rates to near zero and kept pumping money into the economy to keep it afloat during the pandemic. They agreed to let the economy heat up in the interest of a full and inclusive employment goal that spanned race, gender and wealth.
The Fed is not only going to raise rates. They are also going to unload the nearly $9 trillion balance sheet of mortgage-backed securities they bought during the pandemic. 4
Experts predict the most likely result of raising rates and dumping their holdings will be a major stock market drop.
The country now faces a few paths before it can return to normal. Either there will be double digit inflation, a recession, or, worse case scenario, both.
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Notes:
1. https://www.cnbc.com/2022/03/16/federal-reserve-meeting.html
2. https://www.cnbc.com/2022/03/16/federal-reserve-meeting.html
3. https://www.kiplinger.com/economic-forecasts/inflation
4. https://www.cnbc.com/2022/03/16/federal-reserve-meeting.html
