| This week, the Federal Reserve determined that the threat of high inflation was greater than the threat posed by the problems with the banks and raised interest rates another 0.25% to a range of 4.75% – 5%.
Be smart: Here is the Fed’s challenge:
- On one hand, inflation remains well above the Fed’s target rate. It is at 6% and the Fed wants it at 2%. Usually, this situation calls for the continued raising of interest rates.
- On the other hand, there are significant disruptions in the banking sector that are in large part caused by higher interest rates. Additional rate increases could cause more turmoil with spillover effects on the real economy.
Why it matters: This decision should instill confidence that the Fed is still intent on lowering inflation, and that it believes the other steps it has taken to resolve banking issues are sufficient.
Big picture: Inflation was poised to come down quickly in the coming months because the Fed brought the money supply quickly back down to trend (where it would’ve been had the Fed not greatly increased it during Covid).
- Now, the Fed is simultaneously raising rates and increasing the money supply to deal with the banking situation.
- Normally when interest rates rise the money supply contracts. But to support the banks, the money supply will rise while interest rates rise. That increase should not be inflationary like it was before because the money is going to backstop the banking system.
Bottom line: This is all new territory. How this all plays out remains uncertain. |
