Isranomics

Fed’s actions point to economic challenges on horizon

by | Dec 22, 2022 | Economy | 0 comments

Even though the year is nearly over, the Federal Reserve is still working hard to keep inflation under control. Fed Chairman Jerome Powell is following through on his past vow, raising the Fed’s benchmark rate range to 4.25%–4.5%, the highest level in 15 years. The rate hike last week was part of that plan, albeit at a slower pace, with interest rates rising by 0.50% rather than the previously set trend of 0.75%.

However, the latest interest rate decision, as well as Jerome Powell’s press conference that followed, made it clear that the US central bank’s rate hike campaign is not about to end. In fact, based on the wording of Powell’s speech, the interest rate will still grow faster than expected, and for a longer period than markets anticipated. Only a couple of months ago, the Federal Reserve’s officials projected that the interest rate would go as high as 4.6% in 2023, they are now looking at a level of around 5.1%. And, as Powell said, it is possible that it will rise even further. The Fed is not only inclined to raise the interest rate but also sees it as a necessity to leave it there for a period of time. The Fed’s chairman reiterated that he does not see interest rates falling next year. “It is likely that restoring price stability will require holding interest rates at a restrictive level for some time. History cautions strongly against prematurely loosening policy,” Jerome Powell said.

The Fed expects the interest rate to begin declining in 2024, when it will be looking to scale back to 4.10%. However, this is all preliminary, as circumstances may change. According to Powell, the most pressing concern is how high to go before inflation approaches its target of 2%, and only then will it examine whether it is time to begin decreasing interest rates. 

As a result, it is evident that the Fed’s policies thus far have been ineffective in taming inflation, as officials discuss maintaining interest rates high for an extended length of time. The logical question is why such draconian measures are being implemented when inflation is clearly slowing, with the consumer price index falling to 7.1% according to last week’s figures.

There are a few causes for this. According to the Federal Reserve, there are three components to inflation: housing costs, product prices, and labour market conditions. The first two have shown signs of abating, and experts believe the downward trend will continue here. The labour market, on the other hand, poses the most difficulties. Without looking at the details, there are several factors currently contributing to labour shortages on the market. As a result, employment is still reasonably high. So, for the Fed to finally break the proverbial camel’s back, the jobs market must loosen, or unemployment must rise. According to the Fed, this will dampen demand as consumers begin to spend less, causing components of the consumer index to fall. As terrible as it may sound, this is the only way to ensure that inflation does not spiral out of control.

According to Fed officials, unemployment should increase by 0.2% from September’s forecast of 4.45%. At the same time, they predict 0.5% GDP growth in 2023, which is the same as this year. Clearly, this is not a good sign. In principle, when GDP growth is close to zero and unemployment is rising, it is very possible that such a combination will result in economic challenges. When you add a high-interest-rate environment to this equation, it puts the economy on track for a recession. Having said that, there is no conclusive answer to how deep this recession may be. But one thing is certain: the Federal Reserve’s interest rate policy will have a significant impact on how quickly the US economy recovers from these challenging times.

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