The historically low interest rates seen throughout the coronavirus crisis are no longer so.
The Federal Reserve raised its benchmark interest rate on Wednesday, ending a two-year period of rates near zero and taking its biggest step yet toward lowering inflation. The Federal Open Market Committee raised the federal funds rate by 0.25 percentage points, matching forecasts widely held by economists for weeks. This decision kicks off a cycle of rate hikes that should last at least the rest of the year.
“The Committee seeks to achieve a maximum employment and inflation rate of 2% over the long term,” the Fed said in a statement. declaration. “In support of these objectives, the Committee has decided to raise the target range for the federal funds rate from 0.25% to 0.5% and anticipates that continued increases in the target range will be appropriate.”
Wednesday’s rise will reverberate throughout the economy in the coming weeks. Lenders’ rates are directly influenced by the Fed’s benchmark, and when the central bank raises its own rate, borrowing costs nationwide rise slightly. This means that all forms of borrowing, from car loans to credit card interest payments, are about to get slightly more expensive.
The rate hike officially undoes one of the key policy supports the Fed used to help the virus-stricken economy. The central bank cut rates near zero in March 2020 as the spread of the coronavirus triggered widespread lockdowns and froze economic activity across the country. Record-low rates have helped people and businesses borrow money at low cost, giving Americans major support as the country slides into the deepest recession in nearly a century.
But while cheap money provided a bridge for struggling households, it also played a role in allowing inflation to hit fastest pace in four decades. Low borrowing costs encouraged spending and helped demand rebound through 2021. Spending boomed, but supply struggled to keep up. The gap between the two companies led the companies to raise prices at a faster pace, triggering the inflation problem the country is facing today.
The benchmark interest rate is the Fed’s primary tool for cooling the economy and lowering inflation. By raising rates, the Fed can dampen demand and, in turn, address the imbalance that fuels inflation.
Whether the Fed timed its rate decision correctly remains to be seen. Many economists have blamed the central bank for allowing inflation to hit historic highs, arguing that policymakers moved too late to slow soaring prices. Former Treasury Secretary Larry Summers has been among the Fed’s biggest critics in recent months. Summers has repeatedly criticized the Fed for the inflation problem and, in a Tuesday column at The Washington Postsaid the late rate hike risked keeping inflation high and a further economic downturn.
“The Fed’s current policy path is likely to lead to stagflation, with average unemployment and inflation both exceeding 5% on average over the next few years, and ultimately a major recession,” he said. he declared.
Projections released by the Fed on Wednesday indicate that it is rushing to put downward pressure on inflation. Median estimates show that most officials expect at least six more rate hikes in 2022 and more increases the following year. tighten monetary conditions and fight inflation.
Powell indicated at a press conference on Wednesday that the Fed still expects inflation to begin to subside in the second half of 2022. Still, the Fed’s updated projections call for inflation to stay at low levels. higher levels throughout the year and will decline much more slowly than expected in December.
The central bank probably should have started raising rates six months ago, especially given new upside risks to inflation, said Seema Shah, chief strategist at Principal Global Investors.
“With inflation already almost four times higher than its target, the Fed is playing catch-up and clearly recognizes the need to get back to the inflation picture,” she added.