Can Fed Rate Hikes Help The Economy?

7The Fed Reserve is fully committed to combatting inflation, but it has a dilemma. Halting the price rise in the commodities that are the most damaging to Americans’ pockets takes a scalpel, and the Fed’s finest tool operates more like a hammer.

The Fed’s effort to raise interest rates is intended to temper inflation by generally lowering demand. They translate into higher mortgages, vehicle loans, and credit-card debt, all of which slow Americans’ expenditure.

However, the prices that are affecting Americans the most are going unnoticed. Basic goods costs rose again in May as the Ukraine conflict hampered supplies. According to the Consumer Price Index, gasoline prices increased by 4.1 percent during the month, while food expenses increased by 1.2 percent.

Fed Chair Jerome Powell came before the Senate Banking Committee on Wednesday for a semiannual hearing on monetary policy, and lawmakers were quick to point out the central bank’s mismatch. The Fed began raising interest rates in March and has subsequently stepped up its rate hikes. On Wednesday, officials authorized a 0.75 percentage point rate increase, the largest since 1994.

Powell was unequivocal when asked by Massachusetts Senator Elizabeth Warren if interest rate hikes would reduce petrol prices rapidly.

“I would not think so,” the chairman said, adding that higher interest rates would not immediately reduce food inflation.

The disparity strikes at the most serious economic risk confronting the United States. With rate hikes functioning as a relatively blunt tool for broadly targeting investment and consumption across the economy, analysts are concerned that the Fed may overreact by dampening demand. An unexpected drop in consumer spending could force businesses to cut costs by laying off people.

Advertisement

In the worst-case scenario, the United States enters a recession marked by high inflation, high unemployment, and poor growth, a dangerous situation known as “stagflation.” Several Democrats on the committee asked Powell to keep the Fed’s maximum-employment aim in mind, noting that a rapid hike cycle would wipe out part of the labor market’s recovery.

“The risk is that the measures you’re taking will slow down other parts of the economy without getting us the benefit of lower prices,” Maryland Senator Chris Van Hollen told Powell.

For the time being, the Fed is moving quickly to begin lowering inflation. Prices jumped 8.6 percent year on year through May, exceeding analysts’ expectations and representing the greatest price growth since 1981. The reading dashed optimism that inflation had peaked in March and fueled new concerns that the high rate of inflation could become a permanent characteristic of the US economy.

On Wednesday, the chair maintained his belief that the economy is in good shape “very strong and well-positioned to deal with tighter monetary policy

The labor market, which remains “extremely tight,” accounts for a large portion of that strength “Powell stated. There are still around two job opportunities for every available worker, indicating that demand for personnel continues to outweigh supply at an unprecedented rate.

Higher interest rates may cause some pain for workers, but the country has to achieve more sustainable inflation levels “so we can have the labor market that we really want,” Powell said.

“There are parts of the economy where demand exceeds supply and that’s where we think our tools can help,” he said afterward. “The question of whether we’re able to accomplish [a soft landing] is going to depend, to some extent, on factors that we don’t control.”

Advertisement