Will Raising Interest Rates Help The Economy With Inflation?

Read Time:3 Minute, 42 Second

The Federal Reserve Board faces a pivotal decision at its upcoming September 19-20 meeting – whether to raise interest rates for the twelfth time since March 2022 in a bid to curb inflation.

The Federal Reserve Board faces a pivotal decision at its upcoming September 19-20 meeting – whether to raise interest rates for the twelfth time since March 2022 in a bid to curb inflation. With consumer prices soaring and inflation rates stubbornly hovering above the Fed’s target of 2%, the effectiveness of such rate hikes is being scrutinized. Dr. Philip Vinson, an assistant professor of economics at Georgia Gwinnett College’s School of Business, believes that these rate hikes are indeed necessary.

I. Understanding the Inflation Challenge

In June 2022, inflation peaked at a staggering 9.1%, as per Consumer Price Index data. However, by July 2023, inflation had dropped to 3.2%. To the average person, it might seem like inflation hasn’t significantly eased because prices remain high. Dr. Vinson suggests that this perception arises from the expectation that inflation should lead to immediate price reductions, which is not the case.

By raising interest rates, the Federal Reserve Board’s primary objective is not to reduce prices but to bring down the rate of inflation. Dr. Vinson simplifies this by comparing it to running a mile, where the price level represents the distance covered, and inflation reflects the speed of movement. The Fed’s aim is to decelerate the rate of price increases rather than reverse those that have already occurred.

II. The Fed’s Success in Curbing Inflation

In this context, it’s essential to acknowledge the Fed’s success in reducing inflation from its peak of 9%. By implementing multiple rate hikes, the central bank has made significant progress. However, with inflation still exceeding the desired 2%, concerns have arisen that further rate increases might push the economy into a recession.

Dr. Vinson points out that when inflation was in the double digits, the solution was straightforward – the Fed had to raise rates, even if it risked causing a recession. The central bank was willing to make that tough call. However, with inflation now at approximately 3%, the question arises: Is it worth risking a recession over a one-percentage-point difference in inflation? This question lies at the heart of the ongoing debate within the Fed.

III. Impacts of Raising Interest Rates

While raising interest rates can be an effective tool for curbing inflation, it has a range of economic consequences that need to be considered.

Business Growth and Employment: Higher interest rates can stifle business growth and employment opportunities. As borrowing becomes more expensive, businesses may hesitate to seek loans for new projects and hiring. This reluctance to invest in expansion could potentially lead to job cuts and slower economic growth.
Housing Market: The impact of rising interest rates on the housing market is evident. Homeowners who secured mortgages at lower rates may be disinclined to sell, reducing the inventory available to prospective buyers. This supply-demand imbalance can contribute to increased home prices and limited housing affordability.
Stock Market: Dr. Vinson emphasizes a direct causal effect between Fed interest rate hikes and stock market performance. When the Fed raises rates, it often triggers a decline in stock prices. This can be particularly concerning for those near retirement, as their stock-heavy portfolios may take a hit.

Conclusion:

As the Federal Reserve Board gathers to deliberate on whether to raise interest rates, they find themselves at a crossroads. While they have made significant strides in taming inflation from its peak, the challenge now is whether further rate increases are warranted to reach the coveted 2% target. Dr. Vinson’s insights shed light on the intricacies of this dilemma, highlighting the potential consequences of such a decision on various sectors of the economy.

Ultimately, the Fed must weigh the benefits of curbing inflation against the risks of economic slowdown and recession. In this delicate balancing act, they will seek to make the best decision for the nation’s financial stability and prosperity. The September meeting will be a crucial juncture in determining the path forward, and the world will be watching closely as the Federal Reserve navigates these uncharted waters.