As many of you are no doubt aware, inflation is a topic that has been giving business owners, investors, homeowners, lenders, borrowers, and seemingly everybody else, quite the headache over the last couple of years.
Recently, inflation peaked at 9.1% in June, 2022, triggering rumors that the Federal Reserve (FED) would be forced to once again intervene and increase interest rates. Needless to say, when talk of interest rate hikes first began, investors became increasingly nervous, resulting in huge sell-offs in stock markets all over the globe.
Unfortunately, rumor quickly became fact, and the FED did indeed announce an increase in interest rates in an effort to curb inflation, beginning in March, 2022. Then another, then another, and so on. This trend continued well into 2023, yet inflation still remains stubbornly high.
But what exactly is inflation, why did the FED raise interest rates, and why is this seen as such a bad thing? Here’s a look at the FED and their history of increasing interest rates in 2022 and 2023.
What is Inflation?
Before we start crunching numbers and look at the FED’s history of increasing interest rates, we first need to understand why the FED was forced to intervene and hike rates in the first place. The reason? High inflation.
Inflation is basically the rate in which goods and services increase in price over the course of a financial year. The rate of inflation is calculated based upon how much the average basket of shopping goods has increased in price over the course of one year.
Why Did Inflation Rise?
In 2020, when the COVID-19 pandemic first began, economies around the globe ground to a halt. In an effort to keep businesses afloat, interest rates worldwide were slashed, with some countries cutting them down to as much as 0.1%. If you were a borrower, this was good news as it meant that you’d pay virtually no interest at all.
The issue is that people now had more disposable income and that, coupled with stimulus cheques, and other forms of financial assistance also meant that people had more disposable income. This meant people were spending more, which in turn drove up the price of goods.
That, combined with global conflict in Ukraine following Russia’s invasion, shorter supply chains, an increase in federal spending, record-breaking energy prices, and a greater demand for gas and oil meant that inflation soared, peaking at double-digits in some countries, though remaining just below that here in the U.S, peaking at 9.1%.
Why is Rising Inflation a Problem?
If inflation is low, that means that the price of goods and services is increasing slowly. On the flipside, if inflation is high, as it has been since 2022, this indicates that prices are rising rapidly.
This is an issue because when inflation increases, it means that money essentially loses its purchasing power. All of a sudden, a weekly basket of groceries that would cost $50 may now cost $65. That means that money doesn’t stretch as far as it once did.
This is an issue because it means that people essentially are getting less for their money. It impacts the cost of living, and it means that people have less disposable income. From an economic standpoint this is an issue because if people have less disposable income they’re less likely to spend, which means that businesses may suffer. This then reduces economic growth which puts the economy at risk of recession.
The FED and Interest Rates
Because inflation was increasing by so much, when the FED met at their Federal Open Market Committee (FOMC) meeting, they laid out a plan to tackle inflation and bring it down to a manageable level.
When the FED convene at this meeting, they evaluate the economy and decide whether to maintain, reduce, or increase what is known as the FED Funds rate. This is basically the interest rate in which other banks should lend to each other and is the established interest rate which oversees all others.
The FED set a target of 2% for inflation and decided that the most viable way to achieve this target was to hike interest rates.
When the FED met in Jan 2022, chairman Jerome Powell predicted that inflation would fall over the year. But it didn’t. In fact, it increased from 6.34% to 9.1% in June of that same year. The FED set a target of 2% for inflation and decided that the most viable way to achieve this target was to hike interest rates.
Why do Rate Hikes Tackle Inflation?
Basically, when prices rise too quickly, inflation tends to rise sharply, which puts a financial strain on people and the economy. Businesses are forced to increase their prices, which means that workers expect pay increases, yet there is not enough money to meet all these demands. As a result, businesses suffer, people spend less, and the economy suffers, potentially resulting in recession.
The FED decided that the best way to tackle inflation was to increase interest rates. When rates increase, banks are less likely to lend, businesses may need to cut their workforce, and anybody paying any form of interest will all of a sudden be paying more each month. The idea is basically to put a temporary stranglehold on the economy and stop people spending too much, too quickly. When this happens, it means that price increases slow down, which in turn means that goods and services become less valuable, and the spending power of money increases. When this occurs, inflation begins to fall.
The FED and Interest Rate Hikes
In March 2022, the FED implemented their first interest rate increase since 2018, when rates increased from 0% up to 0.25% – 0.50%.
In May, they once again hiked rates from 0.50% – 0.75% – 1.00%. Initially they predicted that this would be enough to bring inflation down, but it wasn’t. A month later, the Consumer Price Index (CPI) which measures inflation, indicated that inflation had peaked at 9.1%.
By February 2023, the FED had increased rates for a 8th time, with rates increasing 4.50% – 4.75%.
There were rumors that February’s interest rate hike would be the FED’s last as inflation was now falling fairly comfortably. However, borrowers, investors, and stock market indices would have to endure rate hikes for a little longer, as the FED didn’t implement their 11th and final rate hike until July 2023…