Financial regulators and central banks have a few tools to combat inflation, and one of those is the adjustment of interest rates. The United States Federal Reserve is moving much more quickly than its European counterpart, the European Central Bank. Faced with an overheating American economy, the Fed had to raise interest rates several months ago, rates that have been quite low for many years. Now, they are set to make a second, abnormally large interest rate increase because their first adjustment was not enough. The Fed raised interest rates by .25 in March, .5 in May, and .75 in June, with the June increase being the largest such increase since 1994. Last week, the Fed upped rates by another .75.
This “front-loading” approach is the Fed’s express attempt at reining in surging inflation. Part of their attempts involves psychological warfare; in order to cool inflation, businesses and consumers must be convinced that the inflation will not last forever. Since the Great Recession, interest rates have been abnormally low as the Fed has tried to get the economy moving again after it nearly crashed. When rates are low, it is meant to add to economic growth. Now, with its recent adjustments, the Fed is setting its tool to neutral; they neither want to add to nor detract from economic growth. Right now, there are too many jobs, and prices are climbing far too quickly for everyone’s comfort.
Experts, of course, are always trying to predict the Fed’s next move. Based on the Fed’s most recent economic projects released in June, experts are predicting that the Fed will increase rates to 3.4 per cent by the end of the year (it was at 1.6% before the late-July increase). This means that the Fed will continue raising the fed funds rate slowly but surely, which writes a very clear message on the wall: a slowdown is coming. That said, this year has been a year that has subverted all expectations. After all, looking even a few months ago, few predicted that today’s current inflation rates would be so high. Because inflation has been difficult to predict, the Fed has also been difficult to predict.
This is a good thing: we want the fed to closely monitor economic data when making its adjustments. Although they seem minor, there is a gigantic difference between an interest rate increase of .5 and .75. The Fed is also hesitant to limit its options down the road. If they do too much too soon, they can be like a driver slamming on the brakes. They want the economy to slow down slightly to regain control; they do not want to skid and slide into a wall. As the world economy continues to evolve in ways we could not have expected just a few years ago; this flexibility will become even more paramount.
Although inflation has been exceeding expectations, most experts are predicting that it will slow considerably once July data gets released. In the US, at least, gasoline prices have fallen considerably, and the Fed’s previous interest rate hikes have had time to cool things down a bit. Being a financial regulator is like being a resort owner; you want it to be hot enough for people to enjoy the beach, but not too hot to where they are sweating.