What’s Up With Interest Rates?

The recent spike in inflation is historical and is being felt not just across the country but across the world. Food and energy prices are hitting record highs and Americans have never before seen prices at the pump so high since the oil and energy crisis of the 70s. The current rise is driven by food and energy costs in the wake of the COVID-19 pandemic and further exacerbated by the Russian invasion of Ukraine, according to the World Economic Forum. While the price of everything continues to rise, the United States Federal Reserve Bank has taken equally historic measures to attempt to slow down the effects of inflation.

Leading Factors

The COVID-19 pandemic initially slowed down economic activity. However, economic stimulus packages from the U.S. federal government allowed U.S. consumers to return to normal levels of economic activity and maintain a strong demand throughout the pandemic. Then, a number of supply chain disruptions caused by COVID-19 and other global supply chain issues made it difficult to meet this consumer demand. The global conflict between Russia and Ukraine has also affected the global supplies from these large exporters. The monthly food price index from the UN Food and Agriculture (FAO) rose over 17% during this period, which reflected the surge in global prices of wheat, of which Ukraine is the world’s largest exporter. The disruption of the global oil supply from Russia also exacerbated the already increasing price of oil per barrel. All leading factors have created the perfect recipe for the inflation of today.

The Fed Responds

The response from the Federal Reserve has been to increase the federal funds rate, the interest rate the Fed charges to lend reserves to banks, by 50 basis points, in its first interest rate hike of that size in more than 20 years. The banks then pass these interest increases onto businesses and consumers, which begins to shift economic activity. The increase in the federal funds rate is a powerful tool that helps the Federal Reserve do its job of controlling inflation. Ultimately, prices on goods begin to drop and businesses also begin to borrow and spend less than usual. The Federal Reserve may increase the rate by another 50 basis points in the coming months if inflation does not slow down quickly enough. However, the Fed also hopes to avoid a recession amidst the effort to slow down inflation.

Wall Street and Consumers

While the Fed attempts to curb the rise of inflation, Wall Street has already entered a bear market. The bear market describes a prolonged period of decline in securities while a symbolic psychological environment sets in of low investor confidence and conservative investment spending. While this may keep Wall Street in a slumber until the economy picks back up, consumers have already started to show signs of decreasing demand. Many large retail chains have initiated aggressive promotions and price reductions to entice consumers and reduce their stockpile of consumer goods.

Looking Forward

The current rise of inflation is due in part to the COVID-19 pandemic, strong consumer demand, global supply chain issues, and global conflict. The Federal Reserve has increased interest rates by a historical amount in hopes that it will have a desirable effect on the increase in inflation. Wall Street has responded by entering a bear market and consumers have started to reduce spending and demand. While many scientists and medical experts agree that COVID-19 is here to stay, many financial experts including the Federal Reserve believe this isn’t the case with inflation.

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