The Federal Reserve is set to raise interest rates for the first time since 2018 as it battles soaring US inflation, the impact of war in Ukraine and the lingering coronavirus crisis.
The Fed has a dual mandate: to maximize employment and keep prices in check. The labor market and broader economy have rebounded impressively from pandemic lows, thanks in part to Fed rate cuts and a massive stimulus program, but prices have risen by 7, 9% in the year to February – the highest inflation rate. in 40 years.
With inflation on the rise worldwide, the Fed is expected to announce that it will follow other central banks, including the Bank of England, and hike rates by a quarter of a percentage point.
Fed Chairman Jerome Powell will also hold a press conference on Wednesday, where he will be asked about the central bank’s plans for future hikes.
Supply chain issues have led to sharp increases in various areas, including used cars, food and utilities, which are causing particular hardship for low-income Americans.
The Fed initially dismissed the price hike as “transitional”, but has since acknowledged that high inflation is likely to be around for some time. Supply problems that seemed to be normalizing earlier this year are also feeling the impact of war in Ukraine and facing further setbacks as China imposes new containment measures to curb new coronavirus outbreaks.
Rising rates too quickly threatens to plunge the United States into recession. This week, CNBC’s Fed survey – which gauges the opinions of fund managers, strategists and economists – put the likelihood of a recession in the United States at 33% over the next 12 months, in up 10 percentage points from the February 1 survey. The latest survey puts the probability of a recession in Europe at 50%.
With inflation at nearly four times the Fed’s 2% target rate, Powell made it clear that the central bank would raise rates in an attempt to rein in rising prices. But some economists wonder what impact the Fed can have on such a complex issue.
JW Mason, associate professor of economics at John Jay College, said a quarter-point rate hike probably wouldn’t have much impact on inflation or the broader economy. “It’s a strange feature of how we think and talk about economics today that we’ve given this over-emphasis on this political tool used by this part of government,” he said.
Mason said he expected inflation to decline without Fed intervention over the next year – albeit “less than we had hoped”. He pointed out that car prices – until recently the main source of inflation – were already falling. While he said a series of small rate hikes is unlikely to have a major impact overall, “a sufficiently large rise in interest rates will have a substantial negative effect on real economic activity” .
Mason said other branches of government are better able to deal with price issues in the wider economy, such as soaring rents and house prices or gas and utility bills, and that tools such as price caps or stimulus checks could be used to mitigate the difficulties.
Testifying before Congress earlier this month, Powell made it clear that he was prepared to raise rates in larger increments of half a percentage point if price increases did not slow.
But he also acknowledged that the economic outlook had been made more complicated by the war in Ukraine.
The dispute is “game changing and will be with us for a very long time,” Powell told the House Financial Services Committee. “There are still events to come…and we don’t know what the real effect will be on the US economy. We don’t know if these effects will be long enough or not.