Fed Hikes Interest Rates Again to Fight Inflation
The Commerce Department reported the U.S. economy shrunk for the second consecutive quarter on Thursday, July 28, 2022, a day after the Federal Reserve lifted interest rates by 0.75 of a percentage point in an aggressive effort to combat inflation and slow economic growth.
The Fed's policy brings the benchmark overnight borrowing rate to a range between 2.25% and 2.50%, increasing borrowing costs on adjustable rates for business and personal loans.
Until runaway inflation shows clear signs of pulling back, some policymakers foresee even more interest rate increases coming in the year’s second half. The Gross Domestic Product, adjusted for inflation, decline of 0.2 percent in the second quarter, the equivalent of an 0.9 percent annual rate decline, adds evidence that the economy is losing momentum. The question is, will the Fed be able to control the inflation rate without the economy going into a downturn?
Here’s a breakdown of what this interest rate hike could mean for you.
What Is The Fed Trying To Achieve?
Policymakers at the Fed often have to prioritize one aspect over another between its mandates: to keep employment levels high and consumer prices stable. When the economy is strong, unemployment rates are typically low, allowing the Fed to focus on controlling inflation. To achieve this, the Fed sets short-term interest rates low, which helps it influence long-term rates. For example, when it raises the short-term interest rates, the cost of borrowing for financial institutions climbs, and financial institutions have no choice but to pass on that increase to businesses and consumers. This means that loans for buying homes or cars become costlier.
The biggest challenge now is that inflation is incredibly high, at an annual rate of 9.1%. Handling this kind of inflation will require drastic measures that the economy could end up weakening substantially. To avoid this eventuality, the Fed is trying to institute a phenomenon called a ‘soft landing.’
This ‘soft landing’ phenomenon is the Fed’s process to slow inflation and economic growth without causing a recession. A soft landing aims to stabilize consumer prices without disrupting employment levels.
Is There Any Way To Tell What The Fed Might Do Next?
It’s really hard to tell and will depend on how the economy performs. Some economists are projecting that at the rate inflation is moving, the Fed may have to work even faster, pushing the interest rates to over 3% by the end of this year.
What Does This Mean For Businesses, Consumers, And The Economy?
For businesses and consumers, high-interest rates mean that loans will become more expensive. This is because financial institutions will have to pay more to borrow money and transfer that high cost to businesses and consumers.
When loans and mortgages become expensive, fewer people can afford higher-priced homes, and businesses will not be able to expand as rapidly. As a result, the economy may slow down, taking the inflation rate down with it.
What it ultimately means for consumers and businesses will depend on whether the pace of inflation slows as quickly and as much as the Fed has forecasted.
We will keep you informed of all the latest updates. In the meantime, see a breakdown of the nation's current overall economic activity, including the state of the labor market and prices.
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