March 20, 2023

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Why Federal Reserve hikes help inflation and what it means

Why Federal Reserve hikes help inflation and what it means

If you live in the United States now, you are probably at least moderately concerned about the economy. From inflation to me Stock marketa lot about money feel so lousy. The good news: The Federal Reserve is taking action to try to bring down inflation and get the economy back to normal. The bad news: The action you take won’t improve everything right away, and in the shorter term, it may make things worse.

“Reducing inflation usually hurts because the Fed basically has the policy toolbox that makes things less expensive because the Fed’s policy toolbox is geared toward cooling demand,” said Gregory Daco, chief economist at EY-Parthenon. “If the Fed can cool demand, there will be less pressure on prices, but cooling demand basically entails making things more expensive.”

To put it more clearly, the idea is to cut back on consumer spending and slow business expansion by increasing costs in other areas (ie, borrowing and loans). The Fed is trying to get you, right now, to stop buying so much stuff.

On Wednesday, the Federal Reserve Starch Interest rates increased by three-quarters of a percentage point, their largest increase in 28 years. The Fed was initially expected to raise rates by a slightly lower rate, but in the midst of May Consumer Price Index hot coming And the Consumer expectations of rising inflationShe acted more aggressively than expected. This marks the third rate increase by the Federal Reserve this year.

The hope is that the Fed’s moves will eventually slow down The prices that people have noticed are definitely going up all around them. But it will also have short-term repercussions. Higher interest rates mean that consumers should expect the cost of credit card debt, mortgages, and car loans, among other things, to rise. The cost of borrowing for companies will also rise, and companies will likely slow down in investing and hiring. Weeks ago, stock markets reflected some concerns about the Federal Reserve as well, as higher interest rates lowered valuations and earnings.

Hard-to-see jungle of trees is a more balanced economy on the other side, but some trees are very prickly.

Prices have already gone up, and we are already in a transitional phase where the economy is slowing down. “The pieces are put in place to rebalance supply and demand, but that doesn’t happen overnight,” said Brian Bethune, a financial economist at Boston College. “The ride is usually bumpy.”

What the Fed is trying to do

The Fed’s position for a while has been that inflation will be temporary: Once some kinks in the economy are resolved, like the supply chain crisis, it will start to fade on its own. But in recent months, the Fed has taken a more assertive stance. Powell Make a hard axisrecognition of inflation isvery highHe points out that he is dedicated to getting rid of it.

Dako explained that the Fed has three main tools at its disposal to try to get the situation under control. The first is advance directive, as in communication, in the sense of speaking to the public and expressing its intentions in terms of monetary policy. Essentially, if the Fed says it will take control of the situation, the public – we hope – thinks it will. The second tool is to raise the federal funds rate – the interest rate that banks charge other banks – which will move through the economy through interest rates and make borrowing more expensive. (With a rise on Wednesday, the federal funds rate was 1.5 to 1.75 percent, and officials expect it to be above 3 percent by the end of the year.) The third is Balance Sheet NormalizationWhich is what the Fed is just doing. It started Unload some assetssuch as treasury bonds and mortgage-backed securities, which should Tightening financial conditionsalthough it will take some time.

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Together, this is intended to deter spending and results in less money falling into the economy overall. There are extensive effects.

“When the Fed tightens monetary policy, it has a direct impact on stock prices, on long-term interest rates, on corporate bond margins, on volatility, on the value of the dollar, and on a number of financial actions,” Dako said.

Firms become more reluctant to invest and hire as credit becomes more expensive, the cost of equity increases, and the environment becomes more volatile. Declining markets have a negative effect on consumer mood, which also affects spending. There is an intended scary effect on the economy – one official hopes it won’t lead to a recession, although there are no guarantees. The Fed is walking a tightrope trying to move from an adaptive easy-money scenario to conditions that are normalizing and tightening — without disrupting the economy too much.

All of this is guaranteed to cause some disruption and problems in the short term, but in the long run, it’s supposed to be worth it.

“We have to take the short-term pain in the economy in order to bring inflation back under control,” said Tara Sinclair, Senior Fellow at Indeed Hiring Lab. She compared raising Fed rates and tightening monetary policy to a medical treatment that would require patients to undergo something painful for long-term health. “Then, going forward, we can have a more stable environment where we know prices are going to grow about 2 percent a year, we have more certainty about that, we have a better sense of both demand and supply. This is a better business environment for the economy as a whole, and companies want That kind of certainty.”

If the Fed does not raise interest rates and examine inflation expectations, the risk is that prices will continue to rise. Workers will also demand higher wages, companies will raise prices to pay those wages, and it becomes kind of a doomsday cycle. The central bank’s job now is to prevent this from happening and to try to prevent high inflation from becoming entrenched.

What does all this mean to you

What a Fed rate hike on Wednesday means, as well as what it does going forward (basically, how fast and how much it moves), for different people, depends on their position in the economy. If you are a saver, this is not a bad deal for you. If you are looking to buy a home, yes.

In recent years, interest rates have been very low and there has been little incentive to save. When rates go up, savers get higher interest rates and can make more money. “Conservative savers who have their money in the bank or bonds or whatever and stay away from risky things get nothing,” Bethune said.

For borrowers, the situation is quite the opposite. Mortgages are really up, with a 30-year fixed rate Hit 6.28 percent this week, up from 5.5 percent last week and well above the average of 3.25 percent in January.

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Car loans will become more expensive, and so will credit card debt.

“For credit cards, they are going to show up very quickly, and it will affect not only the things you buy in the future but also your current balances,” said Matt Schulze, senior credit analyst at Lending Tree. Usually, when the Fed raises interest rates, credit card APRs rise by roughly the same amount over a billing cycle or two, he said. “In general, these single price increases are not enough to shake anyone up financially. The danger is that when you have a lot of them in a short period of time, they add up very quickly and can have a huge impact.”

Firms are likely to slow in expansion and hiring, Which we have already seen in some arenas, such as the technology sector. Depending on how serious the Fed is going forward, the economy could see a slight rise in unemployment and more layoffs. (However, companies may be a little more reluctant to lay off employees given how difficult it is to rehire during the pandemic.) Companies that fear their reluctance to hire can make it even more difficult to find a new job.

If you have money in the stock market, whether you’re day trading with Robinhood or just investing with your 401(k), things really look a bit tricky. In the long run, stocks are generally rising, and most experts advise to do so cling to. Markets can remain volatile for a while, although it is difficult to predict how the market will react to any single news – or, in fact, why it will do anything -.

This won’t be very fun for a while

I would tell you that there are a million things you can do to completely isolate yourself from some of the pain that lies ahead, but then I’d be lying, which I generally try not to do. So instead I will say this: This is disgusting. Everything is expensive, for a while some things will be more expensive, and eventually things will not be more expensive anymore. In the meantime, it wouldn’t be particularly fun. There could be a recession on the way! (But a near-term recession is far from certain.)

One of the things consumers can do to commute right now is to cut back on some spending. Perhaps postpone a summer trip that hasn’t yet been booked, or save the home purchase for a later date, if possible. Walk instead of driving to your destination. “This is something that will put them in a better position going forward, but it will also do their part to contribute to the reduction in demand,” Sinclair said.

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Schulze said that if you have credit card debt, try to pay it off now, before rates go up any further. “This debt is going to get more expensive in a very big hurry. It would definitely be smart to try to get rid of this debt as much as you can,” he said. In her monthly review of credit card offers, Lending Tree have found That the average annual percentage of new credit cards is over 20 percent, the first time since the company began tracking that statistic in 2018. Half of the cards they tracked have increased their APR in the past month.

One fun fact, or rather a tip: Consumers can call and ask for a lower interest rate on their credit cards, and they often find success. according to Lending Treemore than two-thirds of special requests are granted at the credit card’s lowest APR rate.

there Some measures You can try to prepare in the event of an economic downturn, such as building savings and trying to be kinder to your boss. But the real answer about how to prepare for a recession is your kind of inability to.

If you prepare to slack, you will end up sluggish. I mean, it’s very simple. “Economic stagnation is self-fulfilling prophecies,” Dako said. “If someone prepares for a recession, that’s fine, they will cut back on their spending, they will buy a little less, and they will be more careful with their expenditures. this is good. But if 300 million or 350 million people do the same thing, if everyone cuts their spending by 5 percent, well, then there is a 5 percent correction in spending, and that means a recession.”

However, the overall takeaway is that going will be difficult for a while, and some people will be able to manage better than others. “Just put off buying a car” isn’t realistic advice for everyone. There is only so much the Federal Reserve can do about the current economic problems as well. It can take action on the demand side, but there’s not much it can do about supply, which is where a lot of the energy and food price problems stem from. Gas prices are likely to remain high for some time. Other factors putting pressure on prices, such as the Russian war in Ukraine and the global outbreak of the Covid-19 coronavirus, are beyond anyone’s control in the US government.

The The economy that freaks out Right now, even if it’s not really on paper, it’s about to get worse for a lot of people before it finally gets better.

“The long-term situation for which the Fed feels most important is to move forward and reduce pressure on the economy … so that we have a healthier and more stable economy going forward,” Sinclair said. “This will prepare the economy for better growth in the long run.”

Now, everyone will have to wait and see if this ends and, in the meantime, deal with their surging gas receipts and their credit card bills.