The Federal Reserve raised its funds rate on Wednesday by a quarter percent.
The 4.5–4.75 percent rate amounts to the highest in 15 years. Despite this, and Wednesday’s hike becoming the eighth consecutive one, Chairman Jerome Powell explained that “we expect ongoing hikes will be appropriate” and that, given the conditions the Fed anticipates, “it will not be appropriate to cut rates this year.”
All this strikes many in the financial industry as quite unfair. Given that financial institutions borrow from the Fed at that 4.5–4.75 percent rate, more expensive money for them means more expensive money for us when we take out a mortgage, receive a credit card bill, or buy an automobile with a loan. This trickle-down effect naturally reduces demand for what — money — they sell. But if you wish to reduce inflation, then that is kind of the point.
Inflation remains more than triple the Fed’s goal of 2 percent. Perhaps more significantly, the Fed’s rate remains about 2 percent lower than the rate of inflation.
When borrowing money amounts to a better deal than sitting on it, then inflation, not the lending rate, falls into the category of excessive. As former Fed governor Robert Heller points out in a provocative Barron’s article, “At present, the real or inflation-corrected fed funds rate is still negative as the nominal [fed funds rate] is lower than the inflation rate. That means the Fed is still pursuing a stimulative policy.”
That partly explains why demands to slash “high” rates miss the mark.
From early 1977 to late 1991, the federal funds rate never dipped as low as our current “high” rate. It reached 20 percent during the early 1980s. That, relative to the history of the funds rate, is “high.” But 4.5–4.75 percent looks high relative neither to the last 65 years nor to the current rate of inflation. In devising a rate, the latter and not the former primarily matters.
It feels high because the Federal Reserve, unfortunately, pushed its rate to unnaturally low levels. Less than a year ago, the Fed essentially charged financial institutions nothing — zero! — to borrow from it.
That sounds like a nice arrangement until you start buying cases of domestic beer for $25 and gallons of gasoline for $5. That happened in 2022. When the Fed cheapens its money, the Fed cheapens your money. Loose money policies directly resulted in 2022’s painful inflation.
While consumers currently feel some relief compared to the skyrocketing prices experienced during the middle of last year, the latest consumer price index summary showed annual increases for food at 10.4 percent, electricity at 14.3 percent, transportation services at 14.6 percent, and fuel oil at 41.5 percent. The price of eggs, not the price of money, feels exorbitant.
The statement accompanying Wednesday’s hike indicates the Fed gets this. The Federal Open Market Committee informed:
The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the extent of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans.
The persuasiveness of junkies addicted to loose money and perpetually extolling the wisdom of negative interest rates brought the Fed where, to counteract the consequences of such harebrained economics that it previously fell for, it needed to tighten monetary policy. Some of the less zealous within the easy-money ranks experienced the last year as a protracted Pogo epiphany: “We have met the enemy and he is us.”
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