Intensifying its fight against chronically high inflation, the Federal Reserve on Wednesday raised its key interest rate by a substantial three-quarters of a point for the third straight time, 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, from 3% to 3.25%, the highest level since early 2008. Policymakers have also indicated that as early as 2023, they expect to raise rates much higher than they had estimated in June.
The central bank’s move follows a government report last week Showed higher costs spread more widely through the economy, getting worse with rising rents and other services prices even as some previous inflation drivers such as gas prices have eased. By raising lending rates, the Fed makes it more expensive to get a mortgage or an auto or business loan. Consumers and businesses then likely borrow and spend less, cooling the economy and reducing inflation.
Fed officials said they were seeking a “soft landing,” whereby they would manage growth slow enough to control inflation but not enough to trigger a recession. Yet economists are increasingly saying they think the Fed’s steep rate hikes will eventually lead to job cuts, rising unemployment and a full-blown recession later this year or early next.
Chair Jerome Powell acknowledged that in a speech last month Fed move ‘will bring some pain’ Family and business. And he added that the central bank’s commitment to bring inflation back to its 2% target was “unconditional”.
Falling gas prices moderated headline inflation, which was 8.3% in August from a year ago. The drop in gas prices may have contributed to the recent increase in President Biden’s public approval rating, which Democrats hope will boost their chances in the November midterm elections.
Short-term rates at the level the Fed now envisions will sharply increase the cost of mortgages, car loans and business loans, making the recession worse next year. The economy hasn’t seen rates as high as the Fed is projecting since before the 2008 financial crisis. Last week, the average permanent mortgage rate topped 6%, its highest point in 14 years. Credit card borrowing costs are at their highest level since 1996, according to Bankrate.com.
Inflation is now seen to be fueled by higher wages and a steady desire to spend by consumers and supply shortages that have crippled the economy during pandemic recessions. On Sunday, however, Biden said on CBS’ “60 Minutes” that he believes a soft landing for the economy is still possible, suggesting that his administration’s recent energy and health care legislation will lower prices for drugs and health care.
Some economists have begun to worry that the Fed’s rapid rate hikes — the fastest since the early 1980s — will do more economic damage than is necessary to control inflation. Mike Konzal, an economist at the Roosevelt Institute, noted that the economy is already slowing and that wage growth — a key driver of inflation — is flat and some measures are even declining slightly.
Surveys also show that Americans expect inflation to decline significantly over the next five years. This is an important trend because inflation expectations can become self-evident: if people expect inflation to ease, some will feel less pressure to accelerate their purchases. Lower costs will then help increase median prices.
Konzal said a case will be made for the Fed to slow its rate hikes at its next two meetings.
“Given the cold that’s coming,” he said, “you don’t want to rush it.”
The Fed’s rapid rate hikes mirror actions that other major central banks are taking, contributing to concerns about a possible global recession. The European Central Bank raised its 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 all raised rates in recent weeks.
And growth in China, the world’s second-largest economy, is already suffering due to the government’s repeated Covid lockdowns. If the recession goes through most major economies, it could derail the US economy as well.
Even with the Fed’s accelerating pace of 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 believe that massive retrenchment is necessary to reduce rising prices. Research published earlier this month sponsored by the Brookings Institution concluded that unemployment would need to climb to 7.5% for inflation to return 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 would lead to tougher wage growth and reduced consumer spending enough to cool inflation.