The Federal Reserve raised its pivotal short-term interest rate by 0.75 percent for the second consecutive month Wednesday in an attempt to curb soaring inflation, which topped out at a whopping 9 percent for the 12-month period ending in June.
The rate hike, which is the largest since 1994, is designed to raise the cost of borrowing across sectors, which is expected to cool off the over-heating economy. The relevant rate, called the fed funds rate, now sits at a range of 2.25 to 2.5 percent, approaching the long-run rate of 2.5 percent at which the central bank’s monetary policy is supposed to be neither accommodative nor restrictive.
At June’s Federal Open Market Committee meeting, Fed Chair Jerome Powell said, “We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses.” He noted that the Fed is taking a bold approach to restraining inflation, adding that it “can’t go down until it flattens out.”
While oil prices, which are included in headline inflation numbers, have been trending down lately, core inflation, which excludes the more volatile components of energy and food, is still persistently high. Core inflation historically tends to be a better indicator of the true direction of prices.
At a press conference Wednesday, Powell acknowledged that a sustained period of supply shocks, many owing to production bottlenecks caused by the pandemic, “can start to undermine and work on de-anchoring inflation expectations.” When consumers start to factor inflation into their decisions, it has the effect of fueling an inflationary momentum that the Fed’s policy tools can be increasingly ineffective at combatting, he said.
“The public doesn’t distinguish between headline and core inflation,” he added.
When asked whether he agrees with President Biden’s assessment that the economy is not headed towards a recession, despite GDP being poised to shrink for a second consecutive quarter with the release of Thursday’s economic growth data, Powell said, “we’re not trying to have a recession. and we don’t think we have to.”
However, “we think it’s necessary to have growth slow down,” he said. “We’re coming off the high growth re-opening year of 2021. We need a period of growth below potential so we can create some slack so the supply side can catch up.”
“Softening of labor market conditions,” meaning fewer job openings, could come as a result, he noted. Given the current labor shortage and the still extraordinary demand exerting pressure on it, the priority is to restore market equilibrium, Powell suggested.
As for whether the Fed will continue with steep rate increases, Powell said that the decision will be made after Thursday. The next response may include an “unusually large rate increase but we’re going to be guided by the data,” he said.