- Interest rate hikes are the Fed’s best tool to slow inflation.
- But Fed Chairman Powell said Wednesday that rate hikes would not quickly relieve soaring food and gasoline prices.
- The Fed’s ability to quickly calm inflation will depend on certain factors “that we don’t control”, he added.
is in full inflation-fighting mode, but it has a problem. Slowing the spike in prices for the goods that hit Americans’ wallets the hardest requires a scalpel, and the Fed’s best tool acts much more like a hammer.
The Fed’s decision to raise interest rates aims to calm inflation by largely weakening demand. They translate into more expensive mortgages, auto loans, and credit card debt, and those increases tend to slow Americans’ spending.
Yet the prices that hurt Americans the most go unnoticed. Food and energy prices jumped again in May as the war in Ukraine continued to hamper supplies. According to Consumer price index.
Fed Chairman Jerome Powell appeared before the Senate Banking Committee on Wednesday for a semiannual hearing on monetary policy, and lawmakers were quick to expose the disconnect plaguing the central bank. The Fed began raising interest rates in March and has since accelerated its plans for the hike. Authorities on Wednesday approved a rate hike of 0.75 percentage points, marking the biggest hike since 1994.
When Sen. Elizabeth Warren of Massachusetts asked if rate increases would quickly reduce gas prices, Powell was clear.
“I don’t think so, no,” the president said, adding that higher rates wouldn’t immediately calm food inflation either.
The gap hits the biggest economic risk facing the United States. With rate hikes serving as a relatively blunt tool largely targeting investment and consumption across the economy, economists fear the Fed could be exaggerating by weakening demand. A sudden drop in consumer spending could cause companies to cut costs by laying off workers.
In economists’ worst-case scenario, the United States is entering a
characterized by high inflation, high unemployment and slow growth, a harmful phenomenon also known as “stagflation”. Several Democrats on the committee urged Powell to keep the Fed’s maximum employment target in mind, arguing that an aggressive bullish cycle could wipe out some of the rebound in the labor market.
“The risk is that the actions you take will slow other parts of the economy without giving us the benefit of lower prices,” Sen. Chris Van Hollen of Maryland told Powell.
For now, the Fed is moving quickly to try to start cooling inflation. Prices rose 8.6% overall in the year to May, beating experts’ forecasts and reflecting the fastest price growth since 1981. The reading erased hopes that inflation had peaked in March and fueled renewed fears that the high pace could become a permanent feature of the US economy. .
The president reiterated his view on Wednesday that the economy is “very strong and well positioned to handle tighter monetary policy.” Much of that strength comes from the labor market, which remains “extremely tight,” Powell said. There are still about two job openings for every available worker, indicating that demand for employees continues to outstrip supply at a historic rate.
Slowing price growth with higher rates could hurt workers, but the country needs to reach more sustainable levels of inflation “so we can have the job market we really want,” Powell said.
“There are parts of the economy where demand exceeds supply and that’s where we think our tools can help,” he said, adding later. “The question of whether we are capable of accomplishing [a soft landing] will depend, to some extent, on factors beyond our control.”