What is happening
The Federal Reserve is trying to slow inflation by raising interest rates without causing a slowdown, but experts say a “soft landing” seems less likely. The Fed is expected to hike rates next week.
why is it important
With the Fed’s projections to continue raising rates, there will be consequences – most likely a slight uptick in unemployment.
What this means for you
Soaring consumer prices, falling inventories, rising borrowing costs and the threat of layoffs could prove especially devastating for low- and middle-income Americans.
Inflation is not slowing down: this is what the latest Consumer Price Index Data shown this month. In June, inflation increased by 1.3%, putting headline inflation at 9.1% year-on-year. The new record should push the Fed to raise interest rates again, with experts forecasting another 0.75 percentage point hike at the central bank’s next meeting next week.
Raising interest rates is the main action the Fed can take to counter high inflation. When it costs more to borrow – as it doesand other — consumers have less purchasing power and will buy fewer items, decreasing the “demand” side of the supply-demand equation, theoretically contributing to lower prices. But that hasn’t happened yet, and experts fear that the rising cost of borrowing could contract the economy too much, : an economy in decline rather than growth.
Fed chief Jerome Powell has warned that a “soft landing” – achieving 2% inflation with a strong labor market – will not be easy. In an interview with MarketPowell said it will be “quite difficult to accomplish this at this time, for several reasons. The first is simply that unemployment is very, very low, the labor market extremely tight and inflation very high.”
What is causing record high inflation and what will be its impact on the economy? And what is the next step from the Fed? Here’s everything you need to know.
How bad is inflation right now?
In June, inflation soared to 9.1% from a year earlier, reaching its highest level since November 1981, according to the Bureau of Labor Statistics. Gasoline prices rose 11.2% in June, bringing energy’s rise to 41.6% over the past 12 months. Food prices also rose 1% last month, bringing the 12-month increase to 10.4% overall.
During times of high inflation, your dollar has less purchasing power, making everything you buy more expensive, even though you probably aren’t getting paid more. In reality, more Americans are living paycheck to paycheckand wages are not keeping up with inflation rates.
Why has inflation become so high this time around?
In short, much of this can be attributed to the pandemic. In March 2020, the outbreak of COVID-19 caused the US economy to shut down. Millions of employees were laid off, many businesses had to shut down, and the global supply chain was abruptly put on hold. According to Pete Earle, an economist at the American Institute for Economic Research.
But the reduction in supply has been accompanied by increased demand as Americans have started to buy durable goods to replace the services they used before the pandemic, said Josh Bivens, director of research at the Economic Policy Institute. “The pandemic has created distortions on both the demand and supply side of the U.S. economy,” Bivens said.
Although the immediate impacts of COVID-19 on the U.S. economy are easing, labor disruptions and supply and demand imbalances persist, including shortages of microchips, steel, equipment, and other goods, leading to continued slowdowns in manufacturing and construction. Unforeseen shocks to the global economy have made matters worse – particularly subsequent COVID variants, lockdowns in China (which impact the availability of goods in the US) and the war in Ukraine (which affects commodity prices). gas), according to the World Bank.
Powell confirmed the World Bank’s findings at the June Fed meeting, calling these external factors difficult because they are out of central bank control.
Some lawmakers have also accused companies of taking advantage of inflation to raise prices more than necessary, a form of abusive price.
What does the Federal Reserve have to do with inflation?
As inflation hits record highs, the Fed is under heavy pressure from policymakers and consumers to get the situation under control. One of the main objectives of the Fed is to promote price stability and to keep inflation at a rate of 2%.
By raising interest rates, the Fed aims to slow down the economy by making borrowing more expensive. In turn, consumers, investors and businesses stop to make investments and purchases on credit, leading to a reduction in economic demand, theoretically lower prices and a balance between supply and demand. .
The Fed raised the federal funds rate by a quarter of a percentage point in March, followed by half a percentage point in May and three-quarters of a percentage point in mid-June. The federal funds rate is the interest rate that banks charge each other to borrow and lend. And there’s a ripple effect: when it costs banks more to borrow from each other, they make up for it by raising the rates on their consumer loan products. This is how the Fed effectively raises interest rates in the US economy.
The fed funds rate is now in a range of 1.5% to 1.75%. But the Fed thinks that needs to rise significantly to see progress on inflation, likely in the 3.5% to 4% range, according to Powell.
However, rising interest rates can only reduce inflationary pressures to a certain extent, especially when the current factors are largely on the supply side – and are global. A growing number of economists say that the situation is more complicated to control and that the Fed’s monetary policy alone is not enough.
How would a rise in interest rates trigger a recession?
We cannot yet determine how these policy measures will have a general impact on prices and wages. But with three more rate hikes scheduled for this year, there are concerns that the Fed could overreact by raising rates too aggressively, which could trigger a more painful economic downturn or create a recession.
The National Bureau of Economic Research, which has not yet officially determined whether the United States is in a recession, defines a recession as “a significant decline in economic activity that spreads throughout the economy and lasts more than a few months”. This means a decline in gross domestic product, or GDP, alongside falling production and retail sales, as well as falling incomes and falling employment.
Rising rates too quickly could reduce consumer demand too much and unduly stifle economic growth, leading businesses to lay off workers or stop hiring. This would drive up unemployment, which would cause another problem for the Fed, as it is also responsible for maintaining maximum employment.
Generally speaking, inflation and unemployment have an inverse relationship. When more people work, they can afford to spend, leading to increased demand and high prices. However, when inflation is low, unemployment tends to be higher. But with prices that remain exorbitant, many investors are increasingly worried about an upcoming period of— the toxic combination of slow economic growth with high unemployment and inflation.
What do rising interest rates mean for you?
Over the past two years, interest rates had hit historic lows, in part because the Fed cut rates in 2020 to keep the US economy afloat in the face of lockdowns. The Fed has kept interest rates near zero, a decision taken only once before, during the 2008 financial crisis.
For the average consumer, the increase in interest rates means that buying a car or a house will cost more, since you will pay more interest. Higher rates could make it more expensive to refinance your mortgage or student loans. Additionally, Fed hikes will drive up credit card interest rates, which means your debt on outstanding balances will increase.
Securities and crypto markets could also be negatively affected by Fed decisions to raise rates. When interest rates rise, money is more expensive to borrow, reducing liquidity in the crypto and equity markets. Investor psychology can also cause markets to fall, as cautious investors may shift their money from stocks or crypto to more conservative investments, such as.
On the other hand, rising interest rates could mean a slightly better return on your savings accounts. Interest rates on savings deposits are directly affected by the federal funds rate. Several banks have already increased annual percentage yields, or APYs, on their savings accounts and certificates of deposit following the Fed’s rate hikes.
We will keep you updated on the changing economic situation as it evolves.