Going big: Fed issues largest interest-rate hike in 28 years -- with more coming

Going big: Fed issues largest interest-rate hike in 28 years -- with more coming
AP Photo/Manuel Balce Ceneta

The Federal Reserve just issued its largest interest-rate hike in almost 30 years in an effort to tame inflation — and might do it again next month, too. Eschewing the 0.5% rate hike that the Fed signaled over the last few weeks, they surprised the financial markets with a 0.75% rate hike this afternoon. That decision also eschewed the normal unanimity that the Fed likes to preserve on policy decisions of this import:

The Federal Reserve approved the largest interest rate increase since 1994 and signaled it would continue lifting rates this year at the most rapid pace in decades as it races to slow the economy and combat inflation that is running at a 40-year high.

Officials agreed to a 0.75-percentage-point rate rise at their two-day policy meeting that concluded Wednesday, which will increase the Fed’s benchmark federal-funds rate to a range between 1.5% and 1.75%.

The rate increase departed from unusually precise guidance delivered by many members of the rate-setting Federal Open Market Committee in recent weeks indicating they would raise rates by a smaller half percentage point, as officials did at their meeting last month. The committee vote was 10-1, with Kansas City Fed President Esther George dissenting in favor of a half-percentage-point increase.

When it comes to the rest of the year, though, everyone’s in agreement. The rate will hit at least 3% by the end of the year, about where it was before the 2008 financial-sector crisis accelerated into a meltdown:

New projections showed all 18 officials who participated in the meeting expect the Fed to raise rates to at least 3% this year. The median projection would lift the fed-funds rate to around 3.375%, or by an additional 1.75 percentage point over the following four meetings this year. Most officials had projected in March that they would raise rates to at least 1.875% this year.

In fact, Fed chair Jerome Powell declared later that an additional 0.75% hike could come as soon as next month’s meeting. The Fed’s Open Market Committee said it was determined to return inflation to its 2% target:

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 1-1/2 to 1-3/4 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.

Live by quantitative easing, die by quantitative tightening. There’s a certain amount of irony in cheering the Fed’s new decision to use monetary policy to undo the effects of their free-money monetary policy of the last 13 years, but that’s the world in which we live. The problem is that American energy policy and the war in Ukraine may make it almost impossible to rein in inflation to that level through monetary manipulation alone. To the extent that the Fed has to keep tightening the screws to achieve it, it will do considerable damage to employment as well as investment, and therefore economic growth in general.

And as Heather Long points out, they’re already starting to recast their projections for this year and next:

So what does that mean for consumers? It means that mortgages and car loans will get a lot more expensive. Jobs growth will almost certainly stall as the cost of investment will rapidly increase as well:

The move to hike interest rates will make the price of mortgages, auto loans and a wide array of business investments more expensive. Rising interest rates work to cool off an overheated economy by dampening consumer spending, so that demand for goods and services falls, helping bring prices down. However, investors and some businesses are newly concerned that the move to get inflation under control could cool the economy too much, triggering a new recession and a wave of layoffs. …

Fed officials are under pressure to lower inflation and slow the hiring without causing people to lose their jobs. But the Fed cannot do that with any sort of precision. Plus, executing that plan will be exceedingly difficult. Indeed, a new crop of economic projections released at the end of Wednesday’s meeting pointed to a rising unemployment rate, lower economic growth and inflation that takes longer to fall.

The Fed also has a slightly weaker outlook on the U.S. economy for later this year. New Fed projections released today showed the unemployment rate rising, ticking up to 3.7 percent by the end of the year, 3.9 percent in 2023, and 4.1 percent by the end of 2024. That’s higher than the outlook back in March.

Also, the Fed had a more dour look at inflation levels later this year. They are predicting inflation to come down to about 5.2 percent, using their preferred gauge of measuring inflation, which is higher than their earlier estimates.

Fed officials also downgraded this year’s economic growth estimates to 1.7 percent.

Put simply, monetary policy is a sledgehammer when it comes to combating high inflation. A better approach would have been to dismantle the energy policies that disincentivize production, refining, and investment so as to rapidly lower the price on gasoline and diesel especially. Those are force multipliers for inflation as goods and some services move through distribution chains to end-use consumers. That may not have eliminated the excess inflation we experience at the moment — the Fed’s free-money policies since 2009 created the environment for higher inflation — but it would mitigate inflation enough to where the Fed could act more surgically.

Joe Biden, however, won’t relent on his desire to eliminate fossil fuels as a key part of the nation’s energy production, especially for personal vehicles. That leaves the Fed little choice but to swing its sledgehammer, likely more than a few times, to get inflation at least close to its target level of 2%.

And it may not be enough now to prevent a period of stagflation, where consumers fall into a recessionary environment even while inflation and interest rates keep going up. The Commerce Department reported today that consumer spending fell in May by 0.3%; it also shows that spending rose year-on-year by 8.1%, but that doesn’t include inflation, where the CPI is running 8.6% over the same period. If consumers have pulled back on spending already, all of the bad effects of the Fed’s sledgehammering may come a lot more quickly than anyone expects.

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Ben Shapiro 12:01 AM on June 01, 2023