The Federal Reserve has raised interest rates by 0.75 points for the third consecutive time. The Fed is adopting this policy to fight inflation, which is reluctant to come down despite previous rate hikes. Inflation fell from 8.5% in July to 8.3%, when the average forecasted was at 7.7%.
This decision brings rates to between 3.0% and 3.25%. These are levels that have not been seen since 2008. The projection from the Federal Open Market Committee (FOMC), which decides monetary policy, points to interest rates ranging from 4% and 4.5% before the end of the year.
Rates are rising at a rate that hasn't been seen since Fed Chairman Paul Volcker's term in the 1980s. Volcker was then faced with another era of very high inflation, similar to the one from the 1970s. The big difference between that economy and the current one is that inflation coincided with high unemployment (stagflation), while current unemployment rates are very low by historical standards.
Jerome Powell vs Joe Biden
Federal Reserve Chairman Jerome Powell has acknowledged that inflation rates are very high: "If you really look at this year’s inflation—three, six, and 12 month trailing—you see inflation is running too high. It’s running 4.5 percent or above. You don’t need to know much more than that."
This statement goes against Joe Biden's words. In a recent interview with 60 minutes on CBS, Biden acknowledged that the rate is high, but downplayed its recent evolution: "I know it is the highest inflation in the last 40 years. We're in a position where, for the last several months, it hasn't spiked... It's been basically even."
Impact on employment and growth
The Fed raises interest rates in order to curb demand, thereby lowering inflation. But the contraction in demand also has effects on economic activity, and Federal Reserve Chairman Jerome Powell warned that: "If we want to light the way to another period of a very strong labor market, we have got to get inflation behind us. I wish there were a painless way to do that. There isn’t."
In fact, Jerome Powell has mentioned two aspects of the economy that will be affected by the rate hike. On the one hand, he acknowledges that it will affect employment: "We certainly haven’t given up the idea that we can have a relatively modest increase in unemployment. Nonetheless, we need to complete this task." The Fed expects the unemployment rate, currently at 3.7%, to go up to 4.4% in 2023.
The other one is activity. "No one knows whether this process will lead to a recession or, if so, how significant that recession would be. That’s going to depend on how quickly wage and price inflation pressures come down."
It is not just that interest rates are going to rise, but they are likely to remain high for some time. The Wall Street Journal quotes economist Blerina Usuci of T. Rowe Price, who believes that "There is a message here that rates will stay higher for longer, and this message is really sticking with market participants".
