In view of the massive rise in prices in the country, the US Federal Reserve is initiating a fundamental turnaround in monetary policy and is raising its key interest rate for the first time in more than three years. As the Fed announced after a regular meeting of its interest rate policy committee on Wednesday evening in Washington, the so-called overnight target range is now 0.25 to 0.5 percent, and thus a quarter of a percentage point higher than in previous months. The time of the corona-related zero interest rate phase and economic stimulus is thus coming to an end.
According to the central bank, the aim of the step is to curb inflation in the USA, which at 7.9 percent had recently climbed to its highest level in 40 years. A written statement from the Fed said the economic situation in the United States had continued to improve in recent weeks, as had the situation on the job market. However, Russia’s attack on Ukraine will further increase price pressure and weigh on the development of the economy.
Delicate operation: Fed Chair Jerome Powell, seen here in December 2020, is in danger of stalling the economy with rate hikes that are too rapid.
(Photo: AL DRAGO/AFP)
With the overnight money target range, the Fed controls the costs that commercial banks charge each other for short-term lending transactions. It also influences many everyday interest rates, such as those that are due when buying a car or overdrawing an account. An increase by a quarter of a point does not initially have any direct consequences for economic and price development, especially since increases in key interest rates always take effect with a delay of at least six 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 further steps. Before Russia attacked Ukraine, some US experts had expected up to seven increases for this year alone.
As in Germany, the inflation rate in the USA has recently skyrocketed almost unchecked due to the corona-related delivery bottlenecks all over the world. In February it was 7.9 percent, four times the Fed’s target and the highest level since 1981. It’s likely to rise to more in the coming months amid the war in Ukraine and countless other economic disruptors than ten percent possible.
Fear of a wage-price spiral
However, the even greater problem for the Fed is that, unlike in Europe, inflation in the United States has now reached almost all sectors of the economy and has also resulted in significant wage increases. This threatens a so-called wage-price spiral, which central bankers all over the world fear because it can often only be stopped with massive interest rate hikes and by accepting a severe recession.
In order to avoid such a scenario, the Fed is now attempting small rate hikes that are intended to signal its determination to citizens, companies and the financial markets. Increases in key interest rates make loans more expensive, for example for investments or building a house, and thus dampen the economy. The idea is that if the demand for construction and other services falls, the pressure on prices will also fall, and the inflation rate will fall back to the level of around two percent that the central bank considers ideal in the medium term. However, it is uncertain whether the concept of the US monetary authorities will work.
The decisions of Fed Chair Jerome Powell and his colleagues could also fizzle out in view of the countless disruptive factors currently affecting the global economy – or they could achieve the opposite of what is desired. If, for example, the Ukraine war drags on for months or if the stock markets collapse massively, the central bankers could stall the economic engine by raising interest rates too quickly at the very moment when it is already sputtering. In the worst-case scenario, Powell and his colleagues would trigger the very recession they want to avoid. The major bank Goldman Sachs, for example, already estimates the probability that there will be a recession in the USA in the coming year, despite the currently good growth figures, at up to 35 percent.