Fed Interest Rate Hike: What the 0.75 Percentage Point Increase Really Means

This story is part Recession Assistance ServiceCNET’s coverage of how to make smart money moves in an uncertain economy.

What is happening

The Federal Reserve hiked federal funds rates an additional 0.75 percentage points in July. The move could drive up interest rates on mortgages, credit cards, loans and more.

why is it important

With the Fed’s latest rate hike and plans to continue raising rates, there will be consequences – most likely a slight increase in unemployment.

What this means for you

Soaring consumer prices, falling inventories, rising borrowing costs and the threat of layoffs could prove especially devastating for low- and middle-income Americans.

The Fed recently raised interest rates in an attempt to counter rising inflation, but prices have yet to stumble.

And it’s probably not the last rate hike of the year. Jerome Powell, chairman of the Federal Reserve, said he expects further rate increases, totaling a minimum of 1 percentage point by the end of the year. This next rate hike could come as early as September, at the next Fed meeting.

“These rate hikes were significant and they came quickly,” Powell said during the Wednesday press conference. “It’s likely that their full effect hasn’t been felt by the economy. So there’s likely significant additional tightening in the pipeline. While another unusually large increase might be appropriate for our next meeting, it is a decision that will depend on the data that we will continue to make decisions on a meeting-by-meeting basis and communicate our thinking as clearly as possible.”

Raising interest rates is the main action the Fed can take to try to counter high inflation. When it costs more to borrow – as it does credit card, mortgages and other ready — consumers have less purchasing power and will buy fewer items, decreasing the “demand” side of the supply-demand equation, theoretically contributing to lower prices.

But the Fed has yet to be able to rein in inflation, and experts fear further increases in the cost of borrowing could squeeze the economy too much, send us into a recession: an economy in decline rather than growth. The Fed recognizes the perverse effects of this restrictive monetary policy.

“We are very attentive to inflation risks and committed to taking the necessary steps to bring inflation back to our longer-term 2% target,” Powell said. “This process will likely involve a period of below-trend economic growth and some easing of labor market conditions. But such outcomes are likely necessary to restore price stability and set the stage for maximum employment and stable prices. long-term. “

As rates rise and inflation continues to rise, you may be wondering how we got here. We’ll break down everything you need to know about what’s causing record high inflation and how the Fed hopes to drive levels down.

What’s going on with inflation?

In June, inflation soared to 9.1% from a year earlier, reaching its highest level since November 1981, according to the Bureau of Labor Statistics. Gas prices rose 11.2% in June, bringing energy’s rise to 41.6% over the past 12 months. Food prices also rose 1% last month, bringing the 12-month increase to 10.4% overall.

During times of high inflation, your dollar has less purchasing power, which makes everything you buy more expensive, even though you probably don’t get paid more. In reality, more Americans are living paycheck to paycheckand wages are not keeping up with inflation rates.

Why is inflation so high right now?

In short, much of this can be attributed to the pandemic. In March 2020, the outbreak of COVID-19 caused the US economy to shut down. Millions of employees were laid off, many businesses had to shut down, and the global supply chain was abruptly put on hold. According to Pete Earle, an economist at the American Institute for Economic Research.

But the reduction in supply has been accompanied by increased demand as Americans have started to buy durable goods to replace the services they used before the pandemic, said Josh Bivens, director of research at the Economic Policy Institute. “The pandemic has created distortions on both the demand and supply side of the U.S. economy,” Bivens said.

Although the immediate impacts of COVID-19 on the U.S. economy are easing, labor disruptions and supply and demand imbalances persist, including shortages of microchips, steel, equipment, and other goods, leading to continued slowdowns in manufacturing and construction. Unforeseen shocks to the global economy have made matters worse – particularly later variants of COVID-19, lockdowns in China (which limit the availability of goods in the United States) and war in Ukraine (which affects prices of gas and foodstuffs), according to the World Bank.

Powell confirmed the World Bank’s findings at the June Fed meeting, calling these external factors difficult because they are out of central bank control.

Some lawmakers have also accused companies of using inflation as an excuse to raise prices more than necessary, a form of abusive price.

Why is the Federal Reserve raising rates?

As inflation hits record highs, the Fed is under heavy pressure from policymakers and consumers to get the situation under control. One of the main objectives of the Fed is to promote price stability and to keep inflation at a rate of 2%.

By raising interest rates, the Fed aims to slow down the economy by making borrowing more expensive. In turn, consumers, investors and businesses stop to make investments and purchases on credit, leading to a reduction in economic demand, theoretically lower prices and a balance between supply and demand. .

The Fed raised the federal funds rate by a quarter of a percentage point in March, followed by half a percentage point in May and three-quarters of a percentage point in mid-June. In July, the Fed raised interest rates another three-quarters of a percentage point.

The federal funds rate is the interest rate that banks charge each other to borrow and lend. And there is a ripple effect: when it costs more for banks to borrow from each other, they compensate for it by raising the rates on their consumer loan products. This is how the Fed effectively raises interest rates in the US economy.

The fed funds rate is now in a range of 2.25% to 2.5%. But the Fed thinks that needs to rise significantly to see progress on inflation, likely in the 3.5% to 4% range, according to Powell. The Fed’s latest estimate is that by the end of this year, the fed funds rate will be in the range of 3.25% to 3.50%.

However, rising interest rates can only reduce inflationary pressures to a certain extent, especially when the current factors are largely on the supply side – and are global. A growing number of economists say that the situation is more complicated to control and that the Fed’s monetary policy alone is not enough.

Could rising interest rates trigger a recession?

We cannot yet determine how these policy measures will affect prices and wages overall. But with more rate hikes expected this year, there are concerns that the Fed could overreact by raising rates too aggressively, which could trigger a more painful economic downturn or create a recession.

The National Bureau of Economic Research, which has not yet officially determined whether the United States is in a recession, defines a recession as “a significant decline in economic activity that spreads throughout the economy and lasts more than a few months”. This means a decline in gross domestic product, or GDP, alongside falling production and retail sales, as well as falling incomes and falling employment.

Rising rates too quickly could reduce consumer demand too much and unduly stifle economic growth, leading businesses to lay off workers or stop hiring. This would drive up unemployment, which would cause another problem for the Fed, as it is also responsible for maintaining maximum employment.

Generally speaking, inflation and unemployment have an inverse relationship. When more people work, they can afford to spend, leading to increased demand and high prices. However, when inflation is low, unemployment tends to be higher. But with prices that remain exorbitant, many investors are increasingly worried about an upcoming period of stagflation — the toxic combination of slow economic growth with high unemployment and inflation.

Here’s what higher interest rates mean to you

Over the past two years, interest rates had hit historic lows, in part because the Fed cut rates in 2020 to keep the US economy afloat in the face of lockdowns. The Fed has kept interest rates near zero, a decision taken only once before, during the 2008 financial crisis.

For the average consumer, a rise in interest rates means to buy a car or one the house will become more expensive, since you will pay more interest. Higher rates could make it more expensive refinance your mortgage Where student loans. In addition, Fed hikes will drive up interest rates on credit cardwhich means your debt on outstanding balances will increase.

Securities and crypto markets could also be negatively affected by Fed decisions to raise rates. When interest rates rise, money is more expensive to borrow, reducing liquidity in the crypto and equity markets. Investor psychology can also cause markets to fall, as cautious investors may shift their money from stocks or crypto to more conservative investments, such as government bonds.

On the other hand, rising interest rates could mean a slightly better return on your savings accounts. Interest rates on savings deposits are directly affected by the federal funds rate. Several banks have already increased the annual percentage yields, or APY, on their savings accounts and certificates of deposit following the Fed’s rate hikes.

We will keep you updated on the changing economic situation as it evolves.

Source link