In the past year, the Fed has used its ability to increase interest rates as its primary means to fight against inflation, which stood at a 40-year high. However, inflation has slowly been declining in the past few months, decelerating to 6.5% in December 2022, according to the latest Consumer Price Index for All Urban Consumers (CPI-U) report, marking its slowest pace since October 2021.
Although interest rate increases have proven effective, they can also be a dangerous tool. The Fed is walking a thin line between going overboard—jeopardizing the economy in the process—and not doing enough, letting inflation run rampant. The inflation rate is still a far cry from the 2% target rate, and Jerome Powell, the Fed chair, has reiterated his intention to keep up his efforts until inflation is under control.
All likelihoods point toward another interest rate increase after the next Federal Reserve’s policy-making meeting on January 31-February 1, 2023. “Inflation remains high, and policy is going to need to remain sufficiently restrictive for some time to make sure it gets down to 2% for a sustained basis,” said the Fed Vice Chair Lael Brainard. However, the question is, how long does inflation need to stay at 2%?
Divided Opinions Among Economists
So far, the Fed has increased interest rates seven consecutive times. However, the latest increase in December 2022 marked a departure from previous hikes, with the Fed bumping the over-night lending interest rate by 50 basis points instead of the 75 basis point increases of previous months. Regional Fed bank presidents are divided on how much the next increase should be, with some of them arguing in favor of a similar 0.5% raise while others would prefer a smaller 0.25% increase. “I cannot recall a time when we have seen such wide disagreement in terms of the appropriate monetary policy setting,” reports former Fed Economist Ken Kuttner.
One of the main difficulties in establishing what would constitute an appropriate interest rate increase resides in the lag between decision-making, the actual effect of the policy on the economy, and the data reports. In addition, the job market remains robust despite recent layoffs, which may constitute an obstacle to bringing inflation under 2%. “Is it really worth slowing down the economy more to get inflation back down to that 2% level when the labor market is starting to weaken, and you might put people out of work?” asks Derek Tang, an economist at LH Meyer.
We’ll keep you updated on further developments. In the meantime, if you’d like more information about buying/selling or refinancing in today’s market, give us a call or drop us an email.
