The Federal Reserve is expected to raise interest rates by a quarter percentage point Wednesday, a more modest tack that was previously being considered given the war in Ukraine despite historic rates of inflation.
Inflation is currently running hot, with consumer prices increasing by 7.9% for the 12 months ending in February. Some economists such as former Clinton Secretary of the Treasury Larry Summers have been sounding the alarm and calling for the Fed to take action for months, but all indications are that the central bank will increase rates by just a quarter percentage point.
It is exceedingly unlikely that the Fed will take another course of action and raise interest rates more than that because Powell already all but told Congress that he would not be doing a half-point rate hike. Powell told lawmakers during a hearing after Russia invaded Ukraine that he was rather “inclined to propose and support a 25-basis-point rate hike.”
After January’s hotter-than-expected inflation numbers, some Fed watchers began betting that the central bank would decide to do a half-percentage-point rate hike at Wednesday’s meeting rather than the typical quarter-percentage-point raise, which would essentially be the implementation of two rate hikes at once. It would have been the first time the Fed has taken such an extreme move in more than two decades.
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There are differing views on Wednesday’s planned rate hike among economists, but many think that in retrospect, the Fed should have acted sooner to push down on the country’s inflationary pressures.
“It’s not enough. One has got to remember that they are starting from zero, so they are pushing the [rate] up to 0.25% when inflation is running at 7%, so they’re very far behind the curve,” said Desmond Lachman, a senior fellow at the American Enterprise Institute.
Lachman told the Washington Examiner that if the central bank jacks up rates by a half percentage point after messaging a quarter-point hike, it would “really freak people out.” He noted that Powell’s credibility is on the line, and after talking to Congress, he really has no room to back away from that position.
Powell testified that the U.S. economy is in a heightened state of uncertainty, and given the volatility of the situation developing in Russia, the Fed must be careful so as not to add to that uncertainty.
Lachman, who believes slow interest rate hikes should have started at least six months ago and that the Fed should have stopped its bond purchases even earlier, said he hasn’t been pleased with the way Powell has handled inflation and said the chairman’s recent move to opt for the more modest hike is “consistent with his mishandling” of the inflation situation over the past year.
“By losing six to nine months, they are way behind the curve, so to do 25 basis points here is a bit of a joke,” he said.
David Beckworth, a senior research fellow at George Mason University’s Mercatus Center, told the Washington Examiner that because of the war in Ukraine and fresh COVID-19 outbreaks in China, he thinks it is probably OK for the Fed to opt for a quarter-point hike, although he said the Fed needs to be very clear that it is willing to do a half-point hike in the future if it needs to be done.
“They clearly need to raise rates a lot, but I understand why they’re doing it a little bit slower out the gate. They need to also start shrinking the balance sheet immediately — they could have done that already,” Beckworth said. “I think they need to move aggressively, but I can understand their hesitation on this first meeting.”
There are two new concerns that have added to the inflationary puzzle for the Fed.
One fear is that the elevated oil and gas prices that have resulted from the conflict in Europe have the potential to drive up inflation. The other is that COVID-19 keeps spreading across China for a prolonged period and the government decides to shut down factories across the country, resulting in supply-side disruptions.
“The bigger challenge for the Fed is that it needs to respond to the overheating. The economy is running too hot,” Beckworth said, adding that the overheating is not best measured by inflation but rather by how much total spending there is in the economy and if that spending is sustainable.
He said the Fed wants to respond to the inflation that is caused by the spending but not inflation caused by supply shocks, something that is a very tough thing to do for the central bank. Beckworth said he thinks it will be a challenge for the Fed to pull off a safe landing this year.
He said that in a world with perfect foresight, the Fed would have not waited until now to begin raising interest rates and would have done a few quarter-point hikes over the past several months.
Beckworth said that before the war in Ukraine and the COVID-19 outbreaks in China, he would have guessed the Fed could tame inflation down to 3% by the end of this year, although he now thinks the higher prices might go well into 2023.
It is also worth noting that when inflation begins to tamp down, the prices of most goods, commodities aside, will not go down but rather the price increases over the past year are going to be permanent. What will go down with reduced inflation is the pace at which those prices are rising — an important distinction for consumers to understand when watching the Fed hike rates.
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The rate hikes themselves will also be felt by consumers.
Any financing consumers do will now be more expensive, noted Beckworth, who said mortgages are probably where the hikes will affect households the most. But families will also see higher rates for car loans, student loans, and other forms of debt.
