The Federal Reserve’s Open Market Committee will meet again later this month. The popular belief is that the Fed will not raise interest rates. But the latest economic data indicates a rate hike is a distinct possibility.
The purpose of these previously very aggressive rate increases is to reduce total demand in the economy. Since most of the inflation is caused by excessive demand, the rate increases which began in June 2022 are aimed at reducing demand enough to bring the inflation rate down to the 2% level.
Even with the massive interest rate increases in the past 15 months, the inflation rate is still twice as high as the Fed’s target. The Personal Consumption Expenditure is currently over 4%. This is the gauge that the Fed follows most closely.
My view is that the Fed eased up on the rate increases too soon. For the last year, I have been saying that the Federal Funds Rate should be raised to at least 6% to wring inflation from the economy and bring the inflation rate down to the 2% level. In December 2020, just prior to the current administration taking control, the inflation rate was 1.4%.
The current Fed Funds Rate is in the 5.25% to 5.5% range.
The Fed will say that the very aggressive rate hikes during the last half of 2022 have brought the Consumer Price Index down from 9.1% in June 2022, to the 3.2% level where it is today. But the 3.2% rate is a slight increase from the 3% level recorded in the prior month.
Early next week, the CPI for August will be released. That number will be much higher than most people expect. That could raise the twelve-month CPI to near 4%. The following week the Fed meets to decide on further interest rate increases.
Economic activity is slowing considerably from the 6% growth rate seen in 2021 to about 2% today. Since January 2022 economic growth has averaged less than 2%, yet the inflation rate is unacceptably high. This puts the Fed in a difficult position.
Further rate increases will slow economic activity further. The Fed says they can bring the economy to a “soft landing” and avoid a recession. That may be possible, but it is unlikely.
Further rate increases are necessary to reduce demand and put downward pressure on prices.
The excess demand problem was entirely caused by the Federal Government. In 2021 with the economy growing at a 6% rate, the Biden Administration decided to deficit spend nearly $3 trillion. That followed 2020 where the Federal Government deficit spent another $3 trillion.
Last year the deficit was $1.5 trillion. This year the deficit will be about $1.7 trillion. This massive three-year deficit spending added greatly to the excess demand.
At the same time, during all of 2021, the Federal Reserve vastly increased the money supply mostly by printing an additional $240 billion monthly that was used to purchase the bonds that were sold to finance the deficit. This action added further to the excess demand that caused the inflation problem.
Most of the reduction in inflation from mid-2022 to today was due to falling energy prices. The core inflation rate, which excludes very price-volatile food and energy, continues to hover around 5%. The CPI for August will reflect much higher energy prices on top of the 5% core inflation rate.
When that number is released there will be pressure to raise interest rates further. The Fed will probably raise the Fed Funds rate 25 basis points, although to really put a damper on inflation a 50-basis point hike is warranted when they meet later this month.
The Biden Administration has been touting the benefits of Bidenomics. They say that Biden’s economic policies have brought inflation down to nearly 3%. It is, however, the Biden Administration’s policies that contributed greatly to the high inflation. If energy prices had not fallen, inflation would not have dropped to anywhere near 3%.
Consumers continue to spend wildly. They have essentially spent all of the free money that the government handed out to every household during the pandemic. When that was gone, they continued to spend mostly by using their credit card. Consumer credit card debt has topped $1 trillion for the first time.
The only way to reduce credit card spending is by increasing interest rates. Although interest rates are higher than they have been in decades, they are not high enough to stop consumers from using their credit cards.
The Fed will raise interest rates at their next meeting later this month.
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