The US Federal Reserve is hell-bent on curbing inflation—even if it takes a jumbo interest rate hike to do it.
The higher rates could lead to increased joblessness and are already starting to crimp household and business spending, Esther George, the president of the Kansas City Federal Reserve, warned in an interview with CNBC last month.
“These are the unfortunate costs of reducing inflation,” Jerome Powell, the Fed chair, had said in a speech at the Fed’s annual economic symposium in Jackson Hole on Aug. 26. “But a failure to restore price stability would mean far greater pain.”
5.43%: Average interest rate in the US between 1971 and 2022
55%: The chance of a recession in the US within 12 months, according to CNBC’s July survey of 30 fund managers, analysts, and economists
In March 2020, the Fed had cut interest rates to 0% to ease the pandemic’s pressure upon the economy.
Now, with the pandemic “over” and US inflation hitting a 40-year-high, the Fed wants to tame spending. By raising interest rates, the Fed is making it costlier to take out a mortgage or a car, business, or student loan. The hope is that once consumers and businesses borrow and spend less, the economy will cool down and price increases will slow.
But spending is only one factor pushing prices upwards. The global supply chain crunch, exacerbated by covid-19-shutdowns in China and Russia’s war against Ukraine, won’t be affected by interest rates.
“To achieve low inflation rates, currency stability, and faster growth, policymakers could shift their focus from reducing consumption to boosting production,” David Malpass, the World Bank group president, has suggested. “Policies should seek to generate additional investment and improve productivity and capital allocation, which are critical for growth and poverty reduction.”
Without a holistic fix, the rate hikes could trigger a recession in the US and, consequently, around the world.
- The European Central Bank, which raised rates by a historic 75 bps earlier this month, anticipates “several” more rate hikes to fight inflation. This happened even as the euro area slides towards a mild recession.
- On Sept. 20, Sweden’s central bank raised rates by a full percentage point, to 1.75%, as inflation hit a 30-year-high.
- A majority of 47 economists surveyed by Bloomberg expect the Bank of England to raise its main interest rate by at least half a percentage point to 2.25% during its Sept. 22 meeting.
The widening rate differential with the US has pushed the yen to a 24-year low. But unlike several central banks in Asia that mimicked the US with higher costs of borrowing, Japan continues to maintain its easy monetary policy with ultra-low rates.
Haruhiko Kuroda, the governor of the Bank of Japan, is expected to maintain this stance for the remainder of his term, ending in April 2023, given Japan’s weak consumption and the looming risk of a global economic slowdown.