The Times Australia
The Times World News

.
The Times Real Estate

.

Why the Fed raised interest rates by the smallest amount since it began its epic inflation fight

  • Written by William Chittenden, Associate Professor of Finance, Texas State University
Why the Fed raised interest rates by the smallest amount since it began its epic inflation fight

The Federal Reserve’s policy-setting committee lifted interest rates[1] on Feb. 1, 2023, by a quarter of a percentage point to a range of 4.5% to 4.75%. The increase, the smallest[2] since the Fed began an aggressive campaign of rate hikes in March 2022, came amid signs the fastest pace of inflation in decades is cooling[3]. But the Fed also indicated more rate hikes are coming.

So why is the Fed slowing the size of rate increases now, and what does it mean for consumers? We asked finance scholar William Chittenden[4] from Texas State University to explain what’s going on and what comes next.

Why did the Fed raise rates by only a quarter point?

The Fed is trying to figure out whether last year’s rate hikes have slowed the economy enough to get inflation near its target of about 2%.

By raising what’s known as the Fed funds rate, the U.S. central bank makes borrowing more expensive, which means buying large-ticket items, like cars and homes, is more costly. This should lead to fewer people buying cars, which will likely result in lower car prices.

In 2022, the Fed lifted rates eight times by a total of 4.25 percentage points, which helped prompt inflation to drop to an annual pace of 6.5% in December from 9.1% at its peak in June[5].

To understand why it’s so hard for the Fed to figure out if its rate hikes worked, think of the economy as a fully loaded oil tanker out in the ocean. Naturally, it’s chugging along as fast it can to reach a specific destination, but it takes a long time from the captain “stepping on the brakes” to when the ship actually stops moving forward.

Similarly, the Fed is raising rates to slow the economy – sort of like stepping on the brakes – and bring inflation down to 2%, but there’s often a long delay between the hikes and their impact on the economy[6].

But if the Fed eases off the brakes too early, inflation could remain high. If it presses on them too hard, unemployment will likely shoot up and the economy will slide into a recession. By increasing interest rates only a quarter-point, the Fed is signaling that it believes the economy has begun to slow down and is on a path to 2% inflation.

Does this mean borrowing costs will start coming down?

The Fed funds rate acts as a base rate[7] for shorter-term interest rates, such as for car loans and credit cards. As it goes up, short-term borrowing rates increase by about the same amount.

The financial markets are predicting about an 80% chance[8] the Fed’s benchmark lending rate will top out around 5% this summer – which means they’re expecting rates to go just a little bit higher.

Rates on shorter-term borrowing are unlikely to come down, but if markets are right, they probably won’t increase much more.

However, for long-term borrowing costs, as on a 30-year mortgage, rates are already coming down[9] and are likely to fall some more – good news for homebuyers.

How about inflation – can consumers expect prices to start falling?

Overall, yes, inflation is already starting to come down – and prices on some items are even falling[10].

For example, used-car prices, which soared earlier in the COVID-19 pandemic, have dropped[11] in recent months, while prices of dozens of other items[12], such as flour, clothes and gasoline, have eased.

However, some costs continue to increase. Egg prices soared[13] after the supply was disrupted because of avian flu, which killed off nearly 53 million egg-laying hens[14]. Unfortunately, increasing interest rates will not bring back those birds or help decrease the cost of eggs.

In addition, nothing the Fed does will affect the war in Ukraine, which has led to higher world wheat and energy prices[15].

The point being, the Fed can’t really address certain types of inflation.

Does all this mean the U.S. will avoid recession?

That’s the trillion-dollar question.

Fed officials have at times sounded hopeful[16] that they can bring down inflation without crashing the economy – a so-called soft landing. During his press conference after the latest announcement Feb. 1, 2023, Fed Chair Jerome Powell was more cautious[17], saying it’s too soon to declare victory. But he noted: “We can now say for the first time that the disinflationary process has started[18].”

Economic forecasters have been less confident that the U.S. will avoid a recession. On average, economists surveyed this past month by The Wall Street Journal forecast a 61% probability[19] of a recession in 2023. In addition, key economic indicators point[20] to a recession, while the yield curve – a bond market metric that has been successful at predicting recessions – currently puts the odds[21] at about 47%.

In my view, this all adds up to: Nobody really knows. My best advice to consumers out there is to prepare financially for a recession, but let’s not give up hope that the Fed can slow the economy without crashing it.

References

  1. ^ lifted interest rates (www.federalreserve.gov)
  2. ^ the smallest (www.federalreserve.gov)
  3. ^ is cooling (www.nytimes.com)
  4. ^ William Chittenden (scholar.google.com)
  5. ^ 6.5% in December from 9.1% at its peak in June (www.usinflationcalculator.com)
  6. ^ long delay between the hikes and their impact on the economy (www.wsj.com)
  7. ^ The Fed funds rate acts as a base rate (www.bankrate.com)
  8. ^ are predicting about an 80% chance (www.cmegroup.com)
  9. ^ are already coming down (fred.stlouisfed.org)
  10. ^ prices on some items are even falling (theconversation.com)
  11. ^ have dropped (fred.stlouisfed.org)
  12. ^ prices of dozens of other items (www.bls.gov)
  13. ^ Egg prices soared (fred.stlouisfed.org)
  14. ^ killed off nearly 53 million egg-laying hens (www.npr.org)
  15. ^ higher world wheat and energy prices (www.nytimes.com)
  16. ^ Fed officials have at times sounded hopeful (www.bloomberg.com)
  17. ^ was more cautious (finance.yahoo.com)
  18. ^ We can now say for the first time that the disinflationary process has started (finance.yahoo.com)
  19. ^ forecast a 61% probability (www.wsj.com)
  20. ^ key economic indicators point (www.conference-board.org)
  21. ^ currently puts the odds (www.newyorkfed.org)

Read more https://theconversation.com/why-the-fed-raised-interest-rates-by-the-smallest-amount-since-it-began-its-epic-inflation-fight-199057

The Times Features

Best Deals on Home Furniture Online

Key Highlights Discover the best deals on high-quality outdoor furniture online. Transform your outdoor space into a stylish and comfortable oasis. Explore a wide range of d...

Discover the Best Women's Jumpers for Every Season

Key Highlights Explore lightweight jumpers for spring and summer, ensuring breathability and ease. Wrap up warm with cozy wool jumpers for the chilly autumn and winter season...

Uncover the Elegance of Gorgeous Diamond Tennis Necklaces

Key Highlights Diamond tennis necklaces are a timeless piece of jewelry that exudes elegance and sophistication. They feature a continuous line of brilliant-cut diamonds, cre...

Dental Implants vs. Dentures: Which Is Better for You?

When it comes to replacing missing teeth, two of the most common options are dental implants and dentures. Both have their advantages and disadvantages, so choosing between them ...

What Neck Pain Really Means (And Why It’s More Than Just Poor Posture)

Neck pain is often brushed off as something temporary — a tight spot after a long day at the desk or a poor night’s sleep. But when the discomfort keeps returning, it could be a ...

The Work of Gosha Rubchinskiy: Fashion, Culture, and Youth

From Designer to Cultural Architect Gosha Rubchinskiy is not just a fashion designer—he's a cultural force. Born in Moscow in 1984, Rubchinskiy began his career in fashion in t...

Times Magazine

The Essential Guide to Transforming Office Spaces for Maximum Efficiency

Why Office Fitouts MatterA well-designed office can make all the difference in productivity, employee satisfaction, and client impressions. Businesses of all sizes are investing in updated office spaces to create environments that foster collaborat...

The A/B Testing Revolution: How AI Optimized Landing Pages Without Human Input

A/B testing was always integral to the web-based marketing world. Was there a button that converted better? Marketing could pit one against the other and see which option worked better. This was always through human observation, and over time, as d...

Using Countdown Timers in Email: Do They Really Increase Conversions?

In a world that's always on, where marketers are attempting to entice a subscriber and get them to convert on the same screen with one email, the power of urgency is sometimes the essential element needed. One of the most popular ways to create urg...

Types of Software Consultants

In today's technology-driven world, businesses often seek the expertise of software consultants to navigate complex software needs. There are several types of software consultants, including solution architects, project managers, and user experienc...

CWU Assistive Tech Hub is Changing Lives: Win a Free Rollator Walker This Easter!

🌟 Mobility. Independence. Community. All in One. This Easter, the CWU Assistive Tech Hub is pleased to support the Banyule community by giving away a rollator walker. The giveaway will take place during the Macleod Village Easter Egg Hunt & Ma...

"Eternal Nurture" by Cara Barilla: A Timeless Collection of Wisdom and Healing

Renowned Sydney-born author and educator Cara Barilla has released her latest book, Eternal Nurture, a profound collection of inspirational quotes designed to support mindfulness, emotional healing, and personal growth. With a deep commitment to ...

LayBy Shopping