The Federal Reserve has announced yet another rate increase in an effort to increase borrowing costs, slow the economy, and control inflation.
It’s normal to feel like you’ve seen something before. Despite six federal funds rate increases from the Fed this year, inflation is still high due to rising costs for necessities like food and housing.
Although it is marginally lower than the year-over-year peak it reached in June, inflation does not appear to be slowing down. Average prices increased by 8.2% in September over the previous year and by 0.4% from August to September.
The Fed’s primary tool against inflation is rate increases. In the past, when interest rates increase, the high cost of borrowing contributed to the slowdown of the economy by deterring customers from opening new credit accounts. Consequently, prices are lowered. But compared to other decades, the inflation we are currently witnessing is a little different. Inflation is still high today for a variety of reasons, including the conflict in Ukraine, problems with pandemic demand, and the inability of the supply chain to keep up. The Fed has raised rates several times but has yet to succeed in bringing inflation under control.
Many people are concerned that future rises in the cost of borrowing money might cause the economy to contract too much, throwing us into a recession, which is an economy that is contracting rather than increasing. The Fed is aware of the dangers and unfavorable implications of this tight monetary policy.
The Fed has stated that permitting inflation to persist for too long poses a greater hazard than a recession, which would be painful for the economy and American workers. Everything you need to know about rate increases, record-high inflation, and the future of the economy is provided here.
What is the inflation situation?
The year 2022 has seen strong inflation, which peaked in June at a record-high 9.1% year-over-year. Since then, the rate of inflation has generally decreased significantly; according to the Bureau of Labor Statistics, it was 8.2% in September of last year. High inflation rates are mostly the result of rising petrol, food, and housing costs. While the cost of petrol notably decreased in September by 4.9%, continuing a three-month downward trend, the cost of food and housing has continued to rise.
In times of strong inflation, your dollar has less purchasing power, increasing the cost of everything you buy even if you’re probably not generating more money. In actuality, more Americans are struggling to make ends meet since their earnings aren’t increasing at the same pace as prices.
What causes inflation to remain so high?
The pandemic is largely to blame for the current state of the economy. The US economy collapsed in March 2020 as a result of the COVID-19 pandemic’s start. Numerous firms had to close their doors, millions of workers were laid off, and the global supply chain was unexpectedly stopped. According to Pete Earle, an economist at the American Institute for Economic Research, this resulted in the cessation of the flow of commodities developed and manufactured overseas and sent to the US for a minimum of two weeks and, in many cases, for months.
However, as Americans began buying durable products to replace the services they utilised before the epidemic, there was a rise in demand, according to Josh Bivens, director of research at the Economic Policy Institute. This led to a fall in supply. According to Bivens, “the epidemic caused distortions on both the supply and demand sides of the US economy.”
Despite the fact that COVID-19’s immediate effects on the US economy are lessening, labour disruptions and supply-and-demand imbalances—including shortages of microchips, steel, equipment, and other goods—remain, slowing down manufacturing and construction on a long-term basis. According to the World Bank, unexpected economic shocks have made matters worse, including successive COVID-19 iterations, Chinese lockdowns (which limit the supply of commodities in the US), and Russia’s conflict on Ukraine (which is having an impact on gas and food costs).
Some politicians have also charged businesses with price gouging by using inflation as a justification for price increases that are excessive.
The Federal Reserve keeps hiking interest rates, why?
Policymakers and consumers are putting a lot of pressure on the Fed to limit inflation after it reached historic highs. Promoting price stability and keeping inflation at 2% are two of the Fed’s core goals.
The Fed wants to slow the economy by making borrowing more expensive by hiking interest rates. As a result, consumers, investors, and companies hold off on making credit-based investments and purchases, which reduces economic demand and, in theory, pulls prices down and balances supply and demand.
In March and May, the Fed increased the federal funds rate by a quarter and a half percentage points, respectively. After then, it increased rates by a full percentage point in June, July, September, and once more today.
The interest rate that banks charge one another for borrowing and lending is known as the federal funds rate, and it currently ranges from 3.75% to 4%. There is also a cascading effect: When banks have to pay more to borrow money from one another, they make up the difference by hiking the interest rates on their consumer lending products. The Fed essentially raises interest rates in the US economy in this way.
However, raising interest rates only goes so far in easing inflationary pressures, particularly since the present drivers are mostly supply-side and global in nature. A rising number of economists claim that controlling the situation is more difficult than previously thought and that the Fed’s monetary policy is insufficient on its own.
Will the unemployment rate rise?
Over the upcoming year, an increase in the US unemployment rate is anticipated. The BLS reports that the unemployment rate is now 3.5%, while the Fed predicts that it will rise to 4.4% in 2023 in its Summary of Economic Projections.
In the past, increasing rates too rapidly has caused consumer demand to fall too much and unnecessarily hinder economic development, forcing companies to fire employees or cease recruiting. That frequently raises unemployment, creating a new issue for the Fed since it is also responsible for ensuring maximum employment.
In general, there is an inverse link between unemployment and inflation. When more people are employed, they have more money to spend, which raises demand and prices. However, unemployment is more common when inflation is low. However, as prices continue to soar, many investors are growing more concerned about an impending period of stagflation—the dangerous confluence of poor economic growth, rising unemployment, and inflation.
What increased interest rates imply for you is explained here
Increasing interest rates makes it more expensive to buy a car or a house since you’ll have to pay more in interest. Your home or student loans may cost more to refinance if rates rise. Additionally, the Fed’s rate increases will result in higher credit card interest rates, increasing your debt from unpaid amounts.
The Fed’s choices to boost rates may potentially have a detrimental effect on the securities and cryptocurrency markets. When interest rates rise, borrowing money becomes more expensive, which reduces market liquidity in both the cryptocurrency and stock markets. Markets might also fall as a result of investor psychology because cautious investors may switch their funds from stocks or cryptocurrencies to safer investments like government bonds.
On the other hand, increasing interest rates can result in a little greater return on your investments. The federal funds rate has a direct impact on interest rates on savings accounts. Following the Fed’s rate rises, some banks have already raised the annual percentage yields, or APYs, on their savings accounts and certificates of deposit.
