The US Federal Reserve voted yesterday to raise interest rates for the first time since 2018. The reason for this rate hike is inflation, which is at its highest in four decades.
Jerome Powell has a tough road ahead. He faces a dilemma. Tilting one way would ensure that the soaring inflation becomes entrenched. This will result in a bigger hole, so to say, in the pocket of everyday Americans. Tilting the other way would slow down economic growth a tad bit too much.
The Fed's task is somewhat similar to that of a girl in the erstwhile ubiquitous Russian circuses. Walking on a high-wire tightrope, figuratively speaking.
So what is the Fed actually doing here?
Well, it's raising what is known as 'federal fund rates' by a quarter percentage point. The federal fund rates act as a signal for interest rates across the various sections of economy. This slowly filters down to consumers. Americans should expect rates on mortgages, credit cards, students loans and more to experience an upward trajectory as well.
Why is the Fed doing it?
That is obviously the next smart question someone who isn't to sure what this means will have in mind.
When borrowing costs are higher it is in essence meant to -
a.) Curb investments by businesses and consumers.
b.) Encourage savings.
This is what the economy needs at this moment. Consumer prices grew by 7.9 per cent annually in February. As you notice, it is far more than Fed's long run target of 2 per cent.
Now here's the thing, with inflation this high, a mere 0.25 per cent hike is not going to cut it. That's akin to browning your chicken for fricassee with a lighter. The Fed will have to raise rates many more times to put the snake of inflation back in a box.
According to some reports, the Fed is willing to raise interest rates 6 more times this year.
The Other Variables
Past few years haven't been ideal for American economy (and global economy too as a result), to put it delicately. First, a once in a century global pandemic. Then just as the economy was starting to recover, a war in Europe broke out.
Followed by spiralling COVID cases in China's industrial hubs and as a result of China's inept zero-COVID policy, forced lockdowns in these industrial hubs, which will most likely lead to slowdown in production, operation of ports and higher shipping costs.
In an interconnected world, all these different variables put an upward pressure on prices. These certainly won't make the Fed's current task easy, which is applying breaks on rising inflation. The challenge for Powell is to do this without tipping the economy into a recession.
In a press conference, Powell said yesterday that he doesn't believe the U.S. is about to tip into a recession. He believes the US economy is strong enough to absorb these interest rate hikes.
The US Federal reserve faces one of its toughest challenges.
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