Long before the Federal Reserve policymaking committee raised interest rates in 10 consecutive meetings, pundits warned about interest rates as a tool.
Many economists said the Fed’s most prominent mechanism for slowing the economy is too imprecise to bring an overheated economy – one with 40-year-high inflation – into a soft landing, essentially slowing the economy without pushing it into recession.
“The issue will come that we don’t have precision surgical tools,” Fed Chairman Jerome Powell offered in May 2022, after the first two rate increases. “We have, essentially, interest rates, the balance sheet and forward guidance, and they’re famously blunt tools.”
Fed rate hike live updates:Interest rates rise again to further cool inflation
There’s some debate about how much the current interest rate campaign can be credited for the steady drop in inflation, but when you overlay the fed funds rate with the annual inflation rate, you see a textbook example of how the two are expected to work in tandem.
How inflation tumbled as interest rates rose
Fed raises fed funds rate another 0.25% Wednesday
With the Federal Reserve’s policymaking committee’s decision Wednesday, the fed funds range is another 0.25 percentage points higher at 5.25% to 5.5% – a change that will ripple through the economy and likely make borrowing even more expensive.
The question some are asking, though, are how much have those rate increases really affected the economy. Interest rate-sensitive industries such as auto sales and housing have already shown signs – not unlike previous times when the Fed raised rates.
Rising mortgage rates slowed home sales
Flagging home sales are likely just the beginning. Powell often talks about the “long and variable lag” that interest rates changes have on the economy. Historically economists say the full impact of each hike or cut isn’t realized for at least a year.
“I don’t think there’s been that much effect (on inflation) yet,” says Joseph LaVorgna, chief U.S. economist of SMBC Group and a former top economic adviser in the Trump administration. “Most of what has happened has not been Fed related.”
Powell agreed, to a point, on Wednesday after the Fed announced its rate decision.
“Inflation has come down sharply from elevated levels as energy and food prices have come down mostly due to reversal of the effects from the war in Ukraine, and that’s a good thing,” Powell said. Still, taking food and energy out of the mix left core inflation at 4.8% in June – well above the Fed’s 2% target.
Powell said he doesn’t expect inflation to hit its target until 2025 rates, but that doesn’t preclude trimming interest rates from their 22-year high in the interim.
What’s next? Powell said he and policymaking committee will be closely watching two jobs reports and two inflation reports before they meet again on Sept. 19-20 to make their next decision on interest rates.
