Around F.C.

The Fed Has Challenged Inflation to a Duel

The Fed, and more specifically its Federal Open Market Committee, is attempting to combat inflation. The Fed and Chairman Jerome Powell are increasing interest rates, using monetary policy to rein in price increases. If inflation proves to be too powerful, they may not be able to contain these price increases. Worse, this duel could cause collateral damage. Increasing our low level of unemployment or diminishing corporate and consumer confidence, pushing stocks further into bear market territory.

Our banking system is managed by the Federal Reserve among many other federal agencies. The Federal Reserve was established with a mandate to maximize employment, stabilize pricing, and moderate interest rates. You may have heard in September that the Federal Funds rate increased 75 basis points (0.75 percent) to 3.25 percent. The Federal Funds Rate is what commercial banks charge to borrow and lend to one another overnight. Commercial banks in turn lend this money with a spread above it to businesses and consumers.

Mortgage rates begin to increase, increasing monthly payments quite dramatically. As of 2020, an average 30 year loan was comprised of 33 percent interest. Financing the same amount today would amount to 57 percent as interest. Payments would increase 50 percent on the same home and same down payment. Affordability in The Little City is becoming even more distant for those looking to buy. As buyers begin looking at properties within lower price points, others sit on the market longer as sellers consider price cuts.

Not only are mortgages affected, but almost all types of loans. When the cost of borrowing increases, companies and individuals tend to consider spending cuts. As companies observe decreasing demand, they may temper price increases or contemplate price reductions for their products. Today, we may be in a period where the average consumer is evaluating substitutes to meet their budgets, instead of foregoing a purchase altogether. This only muddies the water further. When the Fed increases interest rates, companies of all sizes and types are affected and have to contemplate these changes. What alternative measures can the government take with fiscal policy?

Most of these actions include targeting specific products or services. For example the Inflation Reduction Act aims, among other things, to reduce the cost of specific drugs. Targeting systemic problems may correct flaws related to drug pricing; however economist believe reducing one product is not an impactful action for the economy as a whole.

Other fiscal policies targeting inflation, include the aim to reduce gas prices. As you drive down Washington St, it is easy to notice the price of gas has continued to fall. This will certainly influence inflation, but how sustainable is it? Is it possible to see sub $3.00 prices again without an end to the war in Ukraine?
The Fed’s next meeting is November 1-2. Jerome Powell stated “The chances of a soft landing are likely to diminish to the extent that policy needs to be more restrictive, or restrictive for longer” and the Fed is “committed to getting inflation back down to 2 percent.”