The extent of the problem can be seen last week at “The Salt Line,” a popular and well-located fish restaurant in the south of the US capital, Washington. The makers of the restaurant see themselves as ambassadors of New England cuisine, but for a few days now you have been looking for the heart of the menu in vain: the lobster roll. The price for a kilo of freshly caught Maine lobster is now so obscene, according to the rationale, that even higher earners can no longer be expected to pay it. Instead of lobster, there is now cheaper crab meat in the hot dog bun.
Perhaps the plight of American seafood lovers wasn’t high on the list of topics addressed by the Federal Reserve’s Monetary Policy Committee (Fed) at its routine meeting on Wednesday — less than four kilometers as the crow flies from “The Salt Line.” And yet, after two days of deliberations, the Fed leadership decided not to stand idly by the ever-increasing inflationary pressure and to raise its key interest rate for the first time since the end of 2018: the so-called overnight target range is now 0.25 to 0.5 percent, a quarter of a percentage point higher than so far. And what’s more: by the end of the year, the 18 committee members expect the rate to increase further to almost two percent on average, and even to almost three percent by the end of 2023. If this actually happens, the turnaround in monetary policy would be much faster and more radical than expected weeks ago.
The explosion in lobster prices is an example of the dimension of the problem that worries the monetary watchdogs: if the wave of inflation itself affects an area such as catching local shellfish, which was comparatively little affected by the corona pandemic and the subsequent global supply bottlenecks, so the thought goes , then there really is danger ahead. February’s headline inflation rate was 7.9 percent, four times the Fed’s target and the highest since 1981. It’s likely to rise to more in the coming months given Russia’s incursion into Ukraine and countless other economic disruptions than ten percent possible.
With the overnight target range, the Fed controls the fees that commercial banks charge each other when they lend each other money for a few hours. What is more decisive, however, is that the central bank is also influencing many everyday interest rates, such as those that are due when building a house, buying a car or overdrafting an account: Loans are becoming more expensive, demand is falling, price pressure is easing, and so on the idea. Naturally, a key interest rate increase of a quarter point has hardly any direct impact on inflation and the economy, especially since such measures only take effect with a delay of months. However, it is a clear signal to consumers, companies and politicians that, after months of hesitation, the central bank is now taking the risk of inflation seriously and is ready to take decisive further steps.
“Wages are rising faster than they have been in years”
Fed Chair Jerome Powell said after the committee meeting that the US economy has been in robust condition despite the ongoing pandemic and the Ukraine war. This applies in particular to the labor market, where there is actually such a serious shortage of skilled workers in some areas that employers are outdoing each other with wage increases, bonus payments and job offers. “Wages are rising at the fastest rate in years,” Powell said. He therefore thinks little of expert opinions that predict a recession in the USA for the coming year. There are no signs of that.
However, it is true that the inflation rate will fall later and much more slowly than expected months ago, also because of the Russian attack on the neighboring country. This particularly affects low-income earners. To support these people, “the best we can do is to prolong the current economic upswing. But that requires stable prices,” said the Fed chairman.
In order to achieve this, not only the key interest rates are to be raised much more aggressively than previously planned. Rather, the central bank also wants to reduce its holdings of government bonds and mortgage-backed securities, the purchases of which have kept long-term lending rates low for a long time. A detailed plan for this is to be decided at one of the next committee meetings. The Fed had bought trillions of dollars in securities over the years.
The problem for Powell and his comrades is that they are under pressure from two sides. First, there is record inflation, which is eating away at workers’ wage increases and making many everyday goods and services more expensive. On the other hand, the world economy is constantly facing new problems: In addition to Russia’s war of aggression, these include the omicron outbreak in China and the ongoing conflicts between Washington and Beijing. All of this fuels inflation on the one hand, but at the same time endangers prosperous economic development and thus limits the Fed’s scope for interest rate hikes.
In the worst case, the Fed triggers a recession
In view of the difficult framework conditions, the central bank runs the risk that its decisions will fizzle out – or even achieve the opposite of what is actually intended. If, for example, the Ukraine war drags on for months or the stock markets collapse again, the central bankers could stall the economic engine by raising interest rates too quickly at the very moment when it is sputtering anyway. Or they don’t proceed consistently enough and keep chasing the rising prices. In the worst case, the Fed triggers the very recession it actually wants to avoid.
So a lot has to come together for the central bankers to succeed in making loans so expensive through a whole series of finely dosed interest rate hikes that the economic development is gently slowed down and the inflationary pressure is gradually eased. Experts speak of a “soft landing”, a slow reduction in the growth rate without slipping into recession. A goal that the Fed has pursued several times in its hundred-year history – and has often missed.
The US news portal saw itself in the face of the ever-new problems and disruptive factors in the interest rate policy debate axios already reminded of the mafia film classic “The Godfather III” these days: “Every time you think you’ve managed to get out,” the web service wrote, “you’ll be dragged back in.”