The Federal Reserve on June 15, 2022, lifted interest rates by 0.75 percentage point, the third hike this year and the largest since 1994. The move is aimed at countering the fastest pace of inflation in over 40 years.
Wall Street had been expecting a half-point increase, but the latest consumer prices report released on June 10 prompted the Fed to take a more drastic measure. The big risk, however, is that higher rates will push the economy into a recession, a fear aptly expressed by the recent plunge in the S&P 500 stock index, which is down over 20% from its peak in January, making it a “bear market.”
What does this all mean? The Conversation asked Brian Blank, a finance scholar who studies how businesses adapt and handle economic downturns, to explain what the Fed is trying to do, whether it can succeed and what it means for you.
1. What is the Fed doing and why?
The Federal Open Market Committee, the Fed’s policymaking arm, had been pondering how much and how quickly to raise its benchmark interest rate over the coming months to fight inflation. The stakes for the U.S. economy, consumers and businesses are very high.
Only a week ago, the Fed had been expected to raise rates by 0.5 percentage point at the latest meeting. But markets and Wall Street economists began to expect the larger 0.75-point hike after the May consumer price data suggested inflation has been unexpectedly stubborn. Some Wall Street analysts even argued a 1-percentage-point hike was possible.
The prospect of a faster pace of rate hikes due to inflation has prompted financial markets to plunge by over 6% since the June 10 report. Investors worry the Fed may slow the economy too much in its fight to reduce inflation, which if left unchecked also poses serious problems for consumers and companies. A recent poll found that inflation is the biggest problem Americans believe the U.S. is facing right now.
2. What is the Fed trying to achieve?
The Federal Reserve has a dual mandate to maximize employment while keeping prices stable.
Often policymakers must prioritize one or the other. When the economy is weak, inflation is usually subdued and the Fed can focus on keeping rates down to stimulate investment and boost employment. When the economy is strong, unemployment is typically quite low, and that allows the Fed to focus on controlling inflation.
To do this, the Fed sets short-term interest rates, which in turn help it influence long-term rates. For example, when the Fed lifts its target short-term rate, that increases borrowing costs for banks, which in turn pass those higher costs on to consumers and businesses in the form of higher rates on long-term loans for houses and cars.
At the moment, the economy is quite strong, unemployment is low, and the Fed is able to focus primarily on reducing inflation. The problem is, inflation is so high, at an annualized rate of 8.6%, that bringing it down may require the highest interest rates in decades, which could weaken the economy substantially.
And so the Fed is trying to execute a so-called soft landing.
3. What’s a ‘soft landing’ and is it likely?
A soft landing refers to the way that the Fed is attempting to slow inflation – and therefore economic growth – without causing a recession.
In order to stabilize prices while not hurting employment, the Fed expects to increase interest rates very rapidly in the coming months. Including the latest rate hike, the Fed has already lifted rates by 1.5 percentage points this year, putting its benchmark interest rate at a range of 1.5% to 1.75%.
Historically, when the Fed has had to raise rates quickly, economic downturns have been difficult to avoid. Can it manage a soft landing this time? Fed Chair Jerome Powell has insistedthat the central bank’s policy tools have become more effective since its last inflation fight in the 1980s, making it possible this time to stick the landing. Many economists and other observers remain uncertain. And a recent survey of economists notes that many anticipate a recession beginning next year.
That said, the economy is still relatively strong, and I’d say the the odds of a recession beginning next year are still probably close to a coin flip.
4. Is there any way to tell what the Fed might do next?
Each time the Federal Open Market Committee meets, it seeks to communicate what it plans to do in the future to help financial markets know what to expect so they aren’t taken by surprise.
One piece of guidance about the future that the committee provides is a series of dots, with each point representing a particular member’s expectation for interest rates at different points in time. This “dot plot” previously indicated that the Fed will raise interest rates to 2% by the end of the year and close to 3% by the end of 2023.
The latest inflation news is forcing it to change its tune. The dot plot now suggests the Fed expects rates to near 3.5% by December – implying several large rate hikes are still in store this year – and almost 4% in 2023 before falling again in 2024.
Long-term interest rates, such as U.S. Treasury yields and mortgage rates, already reflect these rapid changes. Some investors, however, think the Fed may have to move even faster and are forecasting rates approaching 4% by the end of 2022.
5. What does this mean for consumers and the economy?
Interest rates represent the cost of borrowing, so when the Fed raises the target rate, money becomes more expensive to borrow.
First, banks pay more to borrow money, but then they charge individuals and businesses more interest as well, which is why mortgage rates rise accordingly. This is one reason mortgage payments have been rising so rapidly in 2022, even as housing markets and prices start to slow down.
When interest rates are higher, fewer people can afford homes and fewer businesses can afford to invest in a new factory and hire more workers. As a result, higher interest rates can slow down the growth rate of the economy overall, while also curbing inflation.
[image_caption]D. Brian Blank[/image_caption]
But what it ultimately means for consumers and everyone else will depend on whether the pace of inflation slows as much and as quickly as the Fed has been forecasting.
D. Brian Blank is assistant professor of finance at Mississippi State University.
This article is republished from The Conversation.
Two points to remember, 1, this inflation we are struggling with was called transitory by Biden and his administration. They couldn’t have been more wrong and believing they have solutions to solve it takes a big imagination. 2, this inflation hurts middle class and lower class the hardest. Gas and groceries prices are out of control, crushing working folks.
You hear a lot of pie in the sky talk about our situation but Americans are tired of hearing shifting blame. Nobody believes “Putin price hikes” are causing our problems. Supply chain disaster is just a pile up on the docks and will be solved in a few weeks…… News flash, still waiting! Baby formula, crime spree, inflation… Voters want results not excuses!!!
No irony in our semi-coherent President trying to crush the fossil fuel industry with regulation and choke off their access to capital, while simultaneously yelling at them to refine more oil. All his handlers had to do was not overreach, but they just couldn’t resist.
What abject nonsense by both you and Joe. If you actually look at US oil production, it fell by around 20% under Trump because of the decreased demand as a result of the pandemic and the fall in oil prices.
As global demand increased after the vaccines, OPEC (led by our great Saudi allies) resolved to decrease supply, to increase oil prices and keep them higher, just as they have sometimes done in the past. The idea that anything Biden did is the “cause” of lower US production after the pandemic (or now) is just a purely political argument, with no basis in reality.
And you know what? Few oil experts think that any increase in possible US production can make up for the current supply disruption, either. As long as Russia’s energy is off the market for most of the world, and the Saudis keep OPEC production down, high gas prices are here to stay. The idea that another incompetent, game-playing Repub Congress would have any ideas to counter that is ridiculous.
I can’t remind people enough that the deal to cut OPEC supplies of oil was negotiated by Trump. It is set to expire this September.
https://www.cnbc.com/2020/04/13/opec-cut-is-trumps-biggest-and-most-complex-deal-ever-dan-yergin.html
I did look at that when you first posted it, Dan. It appears that this was Trump’s brilliant idea for how to stop the price of oil from falling further during the Covid recession: encourage OPEC to cut production until Sept 2022. Another deal whereby our great “deal maker” got taken to the cleaners. America First!
Why not simply guarantee a floor price for domestic producers, with the government buying the barrels for the strategic petroleum reserve? That would have kept oil prices up during the crash. Instead he saddles the world with an OPEC supply cut for 2 years, no matter what. The Art of the (dumb) Deal!
Joe…..Just refer back to late 2019 and early 2020 when your boy Trump and his fawners denied and refused to recognize or do something about the impending covid crisis and thereby created the chain of events which put the economy at the point of where it is now. Had these Republican deniers acted when they had the opportunity, corporations would not be gouging the American public like they now are in order to make up for lost 2020 revenue. Once again….Republicans ‘Asleep at the Wheel’.
Stop blaming the DEMs for everything. It’s childish, immature and disingenuous. It also proves you get your info solely from your REP politicians and planned purposeful propaganda sites like FOX, Newsmax, OAN, QANON & so many more. That is: no thinking required. Just repeat, repeat, repeat. As ol’ Trump has said for years: the more you repeat lies the more people will believe them…. The current economic issues are GLOBAL. The world is struggling. 2 strong drivers have been the Covid pandemic, and Russia’s unfounded attack on Ukraine. Here in America the oil companies have jacked up prices, holding us all hostage, solely to increase their profits. Big business is doing the same on customer goods. Congress could intervene and stop it…and the DEMs are willing & trying! But who keeps throwing a wrench in the gears? The REPs!!!!!! So blame them.
Biden promised to get rid of fossil fuels. Why do you care about gas prices? And why would Exxon invest in increased production and drilling when the know the hammer is coming back down the day after the election?
LK, all I hear from Lefties is excuses. This tragedy started the day Biden Administration went to war with fossil fuels and is squarely on Sleepy Joe. The Left doesn’t correlate stopping pipelines, stopping drilling on Federal land, stopping drilling off shore, increasing regulations to higher gas prices. Enough excuses, please start with solutions.
You’re right, we don’t correlate higher gas prices with any of those things, because (even if you correctly described them) none of them would have had anything to do with causing the higher oil and gas prices we’re seeing all over the world today. World demand has simply overwhelmed the reduction in supply caused by OPEC and Putin’s War.
The oil companies have declined to use the majority of leases they have, as many here have informed you. So canceling some of the (many) unused ones they had is meaningless.
And even as US production ramps up after its significant decline during the pandemic, it can’t possibly make up the global decline in supply.
So that’s the reality, Joe; not what is peddled 24/7 by the Rightwing Noise Machine.
BK, solutions not excuses please. What is Sleepy Joe doing to help Americans during his recession?
A longer response didn’t survive moderation.
The Biden administration has directly addressed the formula shortage, and the Dem Congress just passed a new port oversight bill to address abuses by shippers.
As for gas prices, the cause of the current spike is Putin the Terrible’s war in Ukraine. Do you advocate appeasing the dictator so he will allow the world’s oil to run smoothly again? I’m sure that will be the Putin-adoring Trump’s “solution”.
The real solution was what we should have been doing for the past 40+ years: conservation. Instead we got a nationwide fleet of gas-guzzling SUVs, monster pickups and double-long truck rigs turning the interstate highways into coast to coast rail lines…
Exactly right, there is now clear gas price gouging by Big Oil. The idea that a Repub congress will do anything about that verges on the cretinous.
Gas needs to be regulated like a public utility. Does any sane person think the Repubs would ever agree to that?
AND, Biden did all that to the entire world at once!
Look at the inflation he caused to Venezuela and Turkey!
His failure to re-establish the Iranian nuclear or get North Korea’s COVID under control is just incompetence.
Thanks to Joe Smith and Clarence Lincoln for the “civil, thought-provoking and high-quality public discussion.”
Just a couple of hopefully thought-provoking counterpoints: 1) The President of the United States is not up for election this Fall. 2) The President of the United States has no authority or power to cause or prevent inflation. Inflation is part of the “business cycle” where even experts disagree on the cause and solution. 3) The Republican Party is the Party of “small government” and “hands off” of the economy, meaning they are in principle opposed to doing anything about it even if they knew what caused inflation.
So the only irony I see is in critics of the current President go on as if they or the alternative Republican Party had some “big imagination” for solutions to stop inflation. Or crime or anything other than taxes. We know from 40 years of conservatism, the Republican Party’s imagination is limited to tax cuts for the rich, which even they might concede would do nothing to stop inflation. The Republican Party has no platform, no ideas, no solutions and no imagination. It was, is, and always will be the Party of the Rich, who are those making the big profits from the inflation, gas price hikes, interest rate increases, fear of crime or tainted baby formula. The only thing they lack at this point is total control of elections which will be the result of returning the proxies of the Rich- the Republican Party- to control of the levers of power this Fall.
“The President of the USA has no authority or power to cause or prevent inflation.” Not true. Read history about actions of FDR and Nixon.
A fair point. I should have written “no inherent authority or power to cause or prevent inflation.” My recollection of history is that Presidential authority until 1970 was pretty much confined to proposal or submission of balanced budgets, deficit spending and tax cuts (or increases). But the ultimate decision was up to Congress. The Economic Stabilization Act of 1970 gave authority to Nixon to enact wage and price controls which he and Ford used to try to stop inflation, which, as we who lived through it all remember, were not entirely successful. Ultimately, it was the Federal Reserve under Paul Volker who applied monetary theory to choke the monetary supply, drive up interest rates and precipitate a serious recession that ended inflation in the 1980’s.
Tax cuts are almost always inflationary because they increase the supply of money in circulation. Restoring the tax rates to 2016 levels would be a great way to fight inflation without impacting working class people.
“That said, the economy is still relatively strong, and I’d say the the odds of a recession beginning next year are still probably close to a coin flip.” I don’t even know where to start.
Two quarters of negative GDP prints are a recession and Q1-22 was -1.5% and as of now the Atl Fed GDPNow forecast for Q2-22 is at zero. It’s better then a coin flip odds we are in a recession right now.
Id be curious if this is another expert who assured us inflation was transitory?
Good God, the Fed itself regarded the early stages of the current inflation as transitory! It was mostly “conservatives” who desperately wanted an inflationary economy for their political gain who were arguing otherwise.
As I explained below (and as I see an econ prof has just argued in a new Minnpost piece), Putin’s War entered the equation in March, greatly influencing the scope of the inflationary pressures.
That’s the reality, Clarence.
It’s very likely that the pandemic-related inflation would have been moderating by now had Putin not begun his illegal war of annihilation in March. That has caused severe disruptions and shifts in demand for oil and grain, which has translated into sustained higher food and energy prices.
Unfortunately, energy hits all corners of the largest economies of the globe since it is a crucial input for goods and services. Higher food and energy prices also tend to drive up wages. So Putin’s War has created cost-push inflation that the Fed itself now deems non-transitory.
There wasn’t any thought of a recession on the horizon in Jan 2022, when the stock market hit its high point. Putin’s War has caused a massive negative effect for the world economy, and he is persisting in order to prove that Russia is a “Great Power”, with the ability to screw things up for the world. The question is now whether the nation’s conservatives will call for a Trumpian prescription and seek to end the conflict by appeasing the Russian dictator.
So of course Jon Kingstad has laid out the correct analysis here, while the various “conservatives” are just making absurd non-causal arguments and simply playing politics, because that’s what they do.
No one was issuing any warnings about the economy? Except Larry Summers, and quite a few other economists. In May of 2021 he said:
“I think policy is rather overdoing it,” Summers said in recorded comments at a CoinDesk conference that were released Wednesday. “The sense of serenity and complacency being projected by the economic policymakers, that this is all something that can easily be managed, is misplaced.”
So yes, other than many sane economists not trapped by leftist ideology, no one saw this coming.
Summer’s “warning” in early 2021 covered all the bases regarding inflation, so he couldn’t be wrong. And he now acknowledges that Putin’s War is what’s currently driving inflation.
As for “conservative”-leaning (or funded) economists, they predict government spending will cause high inflation every time a Dem president is elected, so their advice hardly counts as a “warning”.
It was important to come out of the covid recession; that’s what these spending bills achieved. Absent Putin’s War, the Fed’s efforts would likely succeed; with it, it’s hard to tell, unfortunately.
Conserve fuel!