US Federal Reserve to Increase Interest Rates to Maintain Stable Prices? What’s the Real Purpose? It’s difficult to gauge the Fed’s effectiveness at combating inflation, but the key rate remains in a narrow range of 0.25 percent to 0.5 percent. In addition to promoting long-term growth of monetary and credit aggregates, the Fed also has a dual mandate to support the United States economy and to avoid dangerous deflation for common folks.
Fed’s key rate is in a range of just 0.25 percent to 0.5 percent
The Federal Reserve is poised to take some of the biggest steps in three decades to combat inflation, aiming to cool demand for goods and services and moderate price growth. Last month, price inflation hit a record high of 7.9%. The Fed is trying to walk a fine line – too slow and living standards will suffer and too fast, it will knock growth in the US and around the world.
Powell has said recently that the Fed should hike rates quickly to a neutral level, which is roughly 2.4%. This neutral level is very hard to pin down since the economy can change quickly. Most economists think the Fed will hike rates by three half-point increments this year, which would result in a neutral rate of 2.4% by year’s end. That’s the fastest pace since 1989.
Interest rate hikes are Fed’s main tool to combat inflation
When it comes to combating inflation, the US Federal Reserve has many tools, including raising interest rates. Raising interest rates makes a wide variety of loans more expensive, including mortgages. Higher lending costs tend to slow the economy, and lower spending by both businesses and consumers is an indirect result of higher interest rates. But while raising interest rates slows down the economy, it can slow inflation.
Inflation is the biggest concern in the United States, but there are some key differences between the two. Higher inflation means higher prices for most goods. And while the war in Ukraine has increased prices for many commodities, the US Federal Reserve will be closely monitoring the impact of the war on consumer prices. Increasing rates will likely hurt low-income families more than it will affect those on higher incomes.
Consumer price index has soared 7.5% on the year
The Consumer Price Index (CPI) rose more than economists expected in January, showing the inflation rate is now at the highest since 1982. The measure tracks the price changes of a basket of goods and services over a given period. Prices have continued to rise in January despite the global economy’s repair. Grocery prices were the biggest contributor to the increase, up 0.6% month-over-month, and energy prices rose as well.
The overall CPI rose by 7.5% year-over-year in January, compared to economists’ expectations of a 6.5% increase. Fuel oil prices jumped 9.5% month-over-month, tracking the rise in crude oil prices. Meanwhile, electricity costs rose by 4.2%. The jump in food prices was also helpful to the headline index. Overall, food prices increased by 1% in January and by 0.7% a year ago.
Fed has a dual mandate to maintain long run growth of monetary and credit aggregates
In the past, the Fed has been asked to promote full employment, stable prices, and moderate long-term interest rates. While this is a vital goal, it has fallen victim to inflation, as the inverted yield curve has made this objective impossible. In order to promote long-term growth, the Fed must maintain short-term interest rates lower than long-term ones. Achieving this goal is an essential part of sound finance and rational investment conditions.
The dual mandate is often interpreted as achieving maximum employment and stable prices. Both objectives can be achieved at the same time, although it is not always clear how the Fed can accomplish this goal. In the short run, lower inflation rates mean more consumer spending, which results in higher unemployment. On the other hand, low inflation rates result in stable long-term interest rates. The nominal interest rate, which is the difference between the inflation rate and the real interest rate, is the best way to achieve maximum employment.
Fed has a “bygones” strategy for achieving two percent inflation
The Federal Reserve’s policy is to keep inflation near two percent and to distinguish the path of the expected rate from the path of actual inflation. The 2 percent inflation rate is the goal that the Fed has set for the economy over the next several years. This strategy balances the pursuit of price stability with maximum employment, which the Fed does by focusing on the inflation rate. But many economists argue that the Fed should stop focusing on the inflation rate and instead focus on the price level.
The Phillips Curve says that when unemployment is low, inflation should increase. But historically low unemployment did not lead to higher inflation. So, the Fed’s “bygones” strategy may not produce the desired result. Nonetheless, it will continue to monitor inflation and try to implement new policies to achieve two percent inflation. Until this happens, the Federal Reserve should be patient and watch the economy closely.