Should We Raise Interest Rates?
Something that many have been wondering is when inflation is going to fall and get closer to the Federal Reserve’s target rate of 2%. Over the past year, inflation has risen by 6.2%, according to the U.S. Bureau of Labor Statistics. Originally, the Fed anticipated the high inflation to be “transitory” as the U.S. economy recovered from the pandemic and restaurants, businesses, and travel opened back up and consumer demand increased. However, as this occurred the global supply chain struggled to get the flow of goods going again, resulting in backups in all stages of the supply chain. Supply chain backups and labor shortages have contributed to rising costs, as have higher prices for raw materials, creating higher prices for goods. The Fed thought these issues would resolve themselves, hoping the supply chain would begin to flow as normal again. But it hasn’t. Thus, high inflation is still significantly affecting consumers in the U.S.
This is where raising interest rates too late becomes a problem. By letting inflation remain high the Fed runs the risk of long-term inflation, which could create lasting damage to the economy. On the other hand, if the Fed raises interest rates too early, demand could decline as the supply chain issues begin to settle, constricting spending. The effects of this could be levels of inflation that are too low and employment levels that are too low.
Another factor impacting the decision over interest rates is the current bond-buying program. The Fed started buying bonds in response to COVID-19 in order to boost the economy during its economic decline in early 2020. This process, called quantitative easing, is a monetary policy tool that increases the money supply and lowers long-term interest rates. This in turn makes it cheaper for people to borrow money, which allows people to spend more. During the pandemic, this helped boost spending and GDP as the U.S. started to recover. But now, as GDP grows, the Fed has announced that they will begin to slow their bond purchases in order to begin the process of ending the stimulus and thus decreasing the flow of liquidity into the economy.
Over the next couple of months, as the Fed decides what to do about interest rates, they will be closely watching wages and hiring reports, as these indicators reveal wage growth and thus inflationary potential. The Fed will also be watching indicators of consumer expectations of inflation as this can lead to even higher inflation.
Whenever the Fed decides to raise interest rates, it will have significant implications on our economy, and it will define the true end to the global disruptions of COVID-19.
