The Federal Reserve stepped up its fight against chronically high inflation on Wednesday, raising its key interest rate by three-quarters of a point for the third straight time, an aggressive pace that is raising the risk of an eventual recession.
The Fed’s move will raise the 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 signaled that they expect further rate hikes by early 2023, much higher than they had forecast in June.
The central bank’s action follows a government report last week Shows higher costs spread more widely across the economy, price surges for rents and other services are worsening, although some previous drivers of inflation, such as petrol prices, have eased. By raising borrowing rates, the Fed raises the cost of a mortgage, auto or business loan. Consumers and businesses may then borrow and spend less, cooling the economy and slowing inflation.
Fed officials have said they are seeking a “soft landing,” in which they will seek to slow growth enough to curb inflation but not trigger a recession. Economists, however, are increasingly saying they believe a sharp Fed rate hike will lead to layoffs, higher unemployment and a full-blown recession by the end of this year or early next year over time.
Chairman Jerome Powell acknowledged in a speech last month, Fed move will ‘bring some pain’ to homes and businesses. He added that the central bank’s commitment to reducing inflation to its 2% target was “unconditional”.
Falling natural gas prices slightly lowered headline inflation, which remained a painful 8.3% in August compared to a year earlier. Falling natural gas prices could lead to a recent rise in President Biden’s public approval ratings, which Democrats hope will boost their prospects in November’s midterm elections.
The level of short-term interest rates currently envisaged by the Fed will substantially raise the cost of mortgages, auto loans and business loans, making a recession more likely next year. Interest rates in the economy haven’t been as high as the Fed had predicted since before the 2008 financial crisis. Last week, the average fixed mortgage rate topped 6%, the highest in 14 years. Credit card borrowing costs have reached their highest level since 1996, according to Bankrate.com.
Inflation now appears to be driven more and more by higher wages and consumers’ steady desire to spend, rather than by the supply shortages that have plagued the economy during the pandemic recession. On Sunday, however, Biden said on CBS’ “60 Minutes” that he still sees a soft landing for the economy, a sign that his administration’s recent energy and health care legislation will lower the prices of drugs and health care.
Some economists are beginning to worry that the Fed’s rapid rate hikes — the fastest since the early 1980s — will do more economic damage than is needed to keep inflation in check. Mike Konczal, an economist at the Roosevelt Institute, noted that the economy is already slowing, while wage growth — a key driver of inflation — is leveling off, and in some ways even declining.
The survey also showed that Americans expect inflation to slow sharply over the next five years. This is an important trend because inflation expectations can be self-fulfilling: if people expect inflation to moderate, some will feel less pressure to accelerate buying. Reducing spending will help moderate price increases.
Konchar said the Fed has reason to slow rate hikes at the next two meetings.
“Given the cooling that’s coming,” he said, “you don’t want to rush things.”
The Fed’s rapid rate hikes mirrored measures being taken by other major central banks, adding to fears of a potential global recession. The European Central Bank raised its benchmark interest 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 all raised interest rates sharply in recent weeks.
And in China, the world’s second-largest economy, growth has been hurt by the government’s repeated coronavirus lockdowns. If a recession hits most large economies, that could also derail the U.S. economy.
Even as the Fed ramps up its pace of rate hikes, some economists — and some Fed officials — argue that they have yet to raise rates to levels that would actually limit borrowing and spending and slow growth.
Many economists seem to believe that widespread layoffs are necessary to slow price increases. Research published earlier this month under the auspices of the Brookings Institution concluded that unemployment may have to be as high as 7.5% to bring inflation back to the Fed’s 2% target.
According to research by Johns Hopkins University economist Lawrence Ball and two economists at the International Monetary Fund, only a recession as severe as this would reduce wage growth and consumer spending, thereby cooling inflation.