How Will Interest Rate Increases Impact Inflation?

The Federal Reserve will announce a fourth rate hike in 2022 on Wednesday as it competes to curb rapid inflation. Many people in this move wonder why rising interest rates (raising the cost of debt) are America’s main tool for lowering prices.

Senator Elizabeth Warren, Democratic Party of Massachusetts, I wrote an opinion piece The Wall Street Journal on Sunday argues that rising demand crush rates in the Fed are not the right policy to combat inflation today, as fuel costs and supply chain turmoil push up prices. The policy would hurt workers, she said, and “it doesn’t have to be this way.”

Others argue that the Fed should continue to be strong.Former Democratic Treasury Secretary Lawrence H. Summers claimed in an interview with CNN this week The Fed needs to take “strong action” to curb inflation, and allowing inflation to go out of control would be a “big mistake” rather than causing a recession.

Onlookers may be allowed to struggle to understand the argument. The Federal Reserve itself acknowledges that their tools are dull, that broken supply chains cannot be fixed, and that it is difficult to slow the economy sufficiently without causing a recession. So why is the Fed doing this?

The Central Bank of the United States called Paul Volcker, the chairman of the 1980s, “the only game in town” when it comes to fighting inflation. Elected leaders can do what they can to counter rising prices, but raise taxes to curb consumption, spend more on education and infrastructure to increase productivity, and support volatile industries To do. What the elected policymakers can do quickly is generally useful primarily in the surrounding area.

But when it comes to controlling inflation, time is important. If prices continue to rise rapidly over months or years, people will begin to adjust their lives accordingly. Workers may demand higher wages, boost labor costs and encourage businesses to charge more. Companies may begin to believe that consumers will accept price increases and become less cautious about avoiding price increases.

By making the money to borrow more expensive, the Fed’s interest rate movements work relatively quickly to ease demand. People stop doing that as it becomes more expensive to buy a house or car or expand their business. Fewer consumers and businesses competing for the supply of available goods and services can help curb price increases.

Unfortunately, the process can be very expensive at these moments. Balancing the economy when supply is limited — cars are hard to find due to lack of semiconductors, furniture is backordered, and there are more jobs than workers — a significant reduction in demand is needed May become. Significant slowdowns in the economy can wipe out recessions, unemploy workers and reduce family income.

For example, Goldman Sachs economists estimate a 50% chance of a recession over the next two years. Already, the Fed has begun to push up interest rates, so there are many signs that the economy is slowing, with overall growth data, housing market trackers, and some indicators of consumer spending showing a setback.

However, central banks believe that risk is necessary, even if it is difficult to take it. The recession that boosts unemployment is undoubtedly a pain, but inflation is also a major obstacle for many families today. Officials argue that it is important to put it under control in order to put the economy back on a sustainable path.

Federal Reserve Chairman Jerome H. Powell said in a press conference last month that “controlling inflation is essential to sustaining a strong labor market situation that benefits everyone.” ..