The Fed’s Rate Hikes: A Delicate Balancing Act
By The Federal Reserve raised interest rates for the sixth time this week, increasing the benchmark rate by a quarter of a percentage point. This puts the Fed Funds rate at between 4.5% and 4.75%, the highest it’s been since the onset of the Great Recession.
The Fed’s official goal is to bring inflation down to 2%, and its rate hikes are meant to work like brakes, slowing the economy and putting people out of work to reduce spending and curb prices. However, the impact of these rate hikes can take a long time to be felt.[0]
The rate hikes are part of the Fed’s fight against inflation, which has been on a downward trajectory since June, when it hit a peak of 9.1% compared to the year before. Now, it’s down to 6.5%, and the Fed is hoping that further rate hikes will bring it down to 3-4%.
The Fed is relying on the Phillips Curve model to guide its policies, a long-debunked theory that suggests there is a predictable relationship between more inflation and less unemployment.[1] The Fed is essentially trying to bring unemployment up by raising rates, but this is a risky strategy and could easily spiral out of control.[2]
The problem is, it’s not clear that the Fed’s rate hikes are having the desired effect. The U.S. economy grew by 2.1% last year, indicating that the economy is slowing but not tanking into a recession just yet.[3] Consumer spending is also pulling back, and the bond market, the dollar index, and the Fed Funds futures curve are all reacting as they should.[4]
It’s a delicate balancing act for the Fed – raising rates enough to bring down inflation, but not so much that it causes a recession.[5] It’s a tough call, and one that will be made all the more difficult by the unpredictable nature of the economy. For now, the Fed is waiting to see the full effects of its previous hikes before deciding on further action.
0. “MACAU DAILY TIMES 澳門每日時報Interest rates and Fed’s epic inflation fight” Macau Daily Times, 3 Feb. 2023, https://macaudailytimes.com.mo/interest-rates-and-feds-epic-inflation-fight.html
1. “Economist's View: The Fed's Misguided Path on Interest Rates” Commercial Property Executive, 1 Feb. 2023, https://www.commercialsearch.com/news/economists-view-the-feds-misguided-path-on-interest-rates/
2. “Does the Fed actually care about unemployment?” The Boston Globe, 1 Feb. 2023, https://www.bostonglobe.com/2023/02/01/opinion/does-fed-actually-care-about-pursuing-full-employment/
3. “Fed's inflation fight begins yet another tricky chapter” The Washington Post, 31 Jan. 2023, https://www.washingtonpost.com/business/2023/01/31/federal-reserve-january-meeting/
4. “The Fed Has Freed The Market To Dig Its Own Grave” Seeking Alpha, 3 Feb. 2023, https://seekingalpha.com/article/4575140-the-fed-has-freed-the-market-to-dig-its-own-grave
5. “The Many Faces of the Fed – RealMoney” RealMoney, 1 Feb. 2023, https://realmoney.thestreet.com/investing/stocks/fed-what-fed-what-investors-heard-and-wanted-to-hear-on-rates-16115010
