October 6, 2022

Stepping up its fight against chronically high inflation, the Federal Reserve raised its key interest rate by a significant three-quarters of a point for the third time in a row on Wednesday, an aggressive pace that raises the risk of an eventual recession.

The Fed’s move raised its benchmark short-term rate, which affects many consumer and business loans, to a range of 3% to 3.25%, the highest level since early 2008. Policymakers also hinted that by early 2023. they expect further rate hikes much more than they predicted in June.

The central bank’s action followed last week’s government report showed that high costs spread more widely through the economy, with prices for rents and other services deteriorating, although some previous drivers of inflation, such as gas prices, have eased. By raising borrowing rates, the Fed makes it more expensive to get a mortgage or a car or business loan. Consumers and businesses are then likely to borrow and spend less, cooling the economy and slowing inflation.

Fed officials said they were looking for a “soft landing,” which would slow growth enough to tame inflation but not enough to trigger a recession. Still, economists are increasingly saying they think a sharp increase in Fed interest rates will lead, over time, to job cuts, rising unemployment and a full-blown recession late this year or early next year.

Chairman Jerome Powell confirmed this in a speech last month Fed moves ‘will bring some pain’ households and businesses. He added that the commitment of the central bank to reduce inflation to the target of 2 percent was “unconditional”.

Falling gas prices slightly lowered overall inflation, which in August was still a painful 8.3% compared to a year earlier. Falling gas prices may have contributed to a recent surge in President Biden’s public approval rating, which Democrats hope will boost their prospects in November’s midterm elections.

Short-term rates at the level the Fed now predicts would make a recession more likely next year by sharply increasing the cost of mortgages, auto loans and business loans. The economy hasn’t seen rates as high as the Fed predicts since before the 2008 financial crisis. Last week, the average fixed mortgage rate topped 6%, the highest point in 14 years. Credit card borrowing costs have reached their highest level since 1996, according to Bankrate.com.

Inflation now appears to be fueled more by higher wages and the continued desire of consumers to spend, and less by the lack of supply that threatened the economy during the pandemic recession. But on Sunday, Biden told CBS’ “60 Minutes” that he believed a soft landing for the economy was still possible, suggesting that his administration’s recent energy and health care legislation would lower pharmaceutical and health care costs.

Some economists are beginning to express concern that the Fed’s rapid rate hikes — the fastest since the early 1980s — will cause more economic damage than is needed to tame inflation. Mike Konczal, an economist at the Roosevelt Institute, noted that the economy is already slowing and that wage increases — a key driver of inflation — are leveling off and even declining slightly by some measures.

Surveys also show that Americans expect a significant reduction in inflation over the next five years. That’s an important trend because inflationary expectations can become self-fulfilling: if people expect inflation to moderate, some will feel less pressure to accelerate their purchases. Lower consumption would then help moderate price increases.

Konczal said there is reason for the Fed to slow rate hikes over the next two meetings.

“With the cold snap coming,” he said, “you don’t want to rush into this.”

The Fed’s rapid interest rate hike mirrors steps taken by other major central banks, adding to concerns about a potential global recession. The European Central Bank raised the benchmark rate by three quarters of a percentage point last week. The Bank of England, the Reserve Bank of Australia and the Bank of Canada have made significant rate increases in recent weeks.

And in China, the world’s second largest economy, growth is already suffering from the government’s repeated COVID lockdowns. If a recession hits most major economies, it could disrupt the US economy as well.

Even with the accelerated pace of the Fed’s rate hikes, some economists — and some Fed officials — argue that they have yet to raise rates to a level that would actually limit borrowing and spending and slow growth.

Many economists sound confident that widespread layoffs will be necessary to slow price growth. A Brookings Institution-sponsored survey released earlier this month concluded that unemployment might have to rise to 7.5% for inflation to return to the Fed’s 2% target.

According to research by Johns Hopkins University economist Laurence Ball and two International Monetary Fund economists, only a sharp downturn would reduce wage growth and consumer spending enough to moderate inflation.

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