What is the Federal Reserve or the “Fed”? The Fed is the central bank of the United States. It was created as part of The Federal Reserve Act of 1913 and was signed into law by President Woodrow Wilson. What is the role of The Fed? According to federalreserve.gov, The Fed’s responsibilities fall into four general categories. 1) Conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices. 2) Supervising and regulating banks. 3) Maintaining the stability of the financial system. 4) Providing certain financial services to the U.S. government, U.S. financial institutions, and foreign official institutions.
It’s important to understand that while we like to believe we live in a free country with an unregulated economy, that’s actually not the case. Even the best, fairest or freest, economy requires oversight and regulations, or risk economic hardships or collapse. The Fed is the oversight to ensure economic stability. It would be difficult to argue against the importance of The Fed but it’s not unreasonable to dispute policy decisions that will affect all of us.
In order to slow inflation, in March of 2022 the Fed raised the interest rate from near zero to 0.25%. In May it raised the interest rate by 0.50%, in June 0.75% and in July another 0.75%. If the Fed raises the rate at the end of September by another 0.75%, as expected, it will bring the interest rate to 3.0%. What does that mean? It means the cost of money becomes more expensive. Money that’s required to start a business or for research and development. Credit card and home equity loan interest goes up. Mortgages become more expensive. Interest rate hikes slow the economy.
From a practical standpoint, it means the new car or home I was going to purchase becomes unaffordable. So, I delay those purchases for a year or two or more. With car and home purchases slowing, the production of the parts that go into that car slows as demand slows. The renovation on the new house that would have required labor and materials are no longer needed. The raising of interest rates therefore has a snowball rolling downhill effect on the entire economy.
With a slowing economy, companies begin layoffs. People have less or no disposable income, so they stop purchasing anything but essential products. As demand slows, prices decrease. Simple supply and demand economics. Companies need to sell and replenish their inventories, so they lower their prices to move inventory. So, there’s no question that raising interest rates will eventually bring down inflation. The question then becomes, how high do interest rates have to go before feeling the effects?
We then need to ask if raising interest rates to bring down inflation is the right approach in this economy? Examining the current environment, unemployment is still at a very low 3.7%. Job growth, while lower than expected still added a robust 315,000 jobs to payrolls in August. Those are great numbers considering we’re still recovering from the shutdown of our economy. Do we destroy people lives due to the Fed’s obsession with inflation?
Inflation is not a good thing but there are two ways to look at it. Is it better to enjoy full employment, with high inflation? Or is it better to have high unemployment with low inflation? Struggling to survive is far better than not surviving. So, I choose the former. If you’re homeowner with a fixed mortgage, your payment stays the same, regardless of the interest rate. Is it better to lose your job so inflation comes down, but not be able to afford your mortgage, or to keep your job, pay your mortgage and eat out less frequently?
Food in the supermarket has certainly increased in price. But is it so expensive as to be unaffordable? Perhaps it means a temporary break from shopping at Wholefoods? Aldi may be an alternative. It may mean sacrificing a vacation or other luxuries that people don’t want to sacrifice. But isn’t that preferable to losing your job and not being able to afford anything? At least some of this inflation is due to the pandemic and the war in Ukraine. Both events, highly irregular and need to be taken into consideration when looking at policy decisions.
Those at the Fed don’t appear capable of thinking outside the box. Trying something different as opposed to raising and lowering interest rates as the only effective measure for heating and cooling the economy, would be a welcome change. Before raising interest rates, our political leaders need to focus on increasing oil production and refinery capacity which would in turn help ease energy prices. Food has increased largely due to the fact that it’s so much more expensive to truck it to our supermarkets. Out of control fuel prices are passed on to the retailers, who in turn pass it on to consumers.
Drill baby drill is what we need to get through this period even as we continue to work towards green energy. President Biden killed the Keystone Pipeline as his first order of business and that hasn’t helped our fuel prices, even though, those on the left say the pipeline wouldn’t have helped. Let us not forget that during the Trump administration, the US exported more crude oil and petroleum products than it imported. That’s no longer the case. Perhaps not energy independence by definition, but better than the Obama administration, and better than the Biden administration. We need to convert to green energy, but we are putting the cart before the horse.
If the Fed does raise the rate by another 0.75, expect the country to fall into a recession. It will not be avoided. I think it’s the wrong approach until all other solutions are exhausted. But due to the narrow thinking of those at the Fed raising interest rates is the only option. Kill the economy to bring down inflation so people who are struggling to buy things, will no longer be able to buy anything. It’s crazy logic and totally wrong. We’ll find out before long. The only question will then be, how long before the layoffs begin?