The Federal Reserve and it’s Successful Fight (so far) in Defeating Inflation
It’s hard to believe, but the big economic story of 2023 is the likelihood of the defeat of inflation. Inflation (as measured by the Consumer Price Index – CPI) reached a high of 9.1% in June of 2022 (this is in comparison to the June 2021 reading). Now, the inflation rate for December of 2023 stands at just 3.1%. While this news is great overall, there may be a downside – more on that later.
The Federal Reserve (The FED), after making some major mistakes, chief among them was not raising interest rates quickly enough and believing that the inflation rise was merely “transitory,” seems to have finally gotten it right.
If we recall interest rates were near 0% for years, as the FED tried to spur the economy and increase expansion. But as expansion increased, so did inflation. The FED finally began to consistently raise interest rates to slow down a too quick expansion and the accompanying inflation in March of 2022. (The Fed meets 8 times a year.) In March, the rise was .25%, in May it was .50%. Then from June until November June, it was .75%, before cutting back interest raises to .50% in December of 2022. The Fed then eased the rate increases to .25% from February until May of 2023 and again in July. After July, the Fed held rates steady until today.
The purpose of raising interest rates was to make borrowing more costly, hence slowing down the economy to curb inflation. When rates are high both businesses and individuals are less likely to borrow and, therefore, less likely to expand or make purchases. And since inflation’s root cause is too much money chasing too few products, inflation had to be halted. In simple terms, easy money (meaning very low borrowing costs) encouraged businesses and individuals to spend – and over-the-top spending causes inflation.
As of now, things are heading in the right direction. The latest inflation report which is generated by the Bureau of Labor Statistics showed that the Consumer Price Index rose by just 3.1% in December 2023 compared to a year earlier.
The great news is that virtually all analysts believed that raising interest rates so quickly and so much would cause a recession (it always did in the past); the only discussion was how bad the recession would be. But now it seems that a recession is not in the cards. This is referred to by economists as a “soft landing.”
Inflation rates have declined in the last 12 months, and in most cases it’s a sharp decline. In five categories - groceries, clothing, transportation, medical care and household energy, inflation has halted.
When I mentioned at the beginning of the article, “more on that later,” the only outlier is housing, because rents are still elevated. But good news is coming here too. Data for new lease signings shows that rents are declining, which should result in savings for many renters as their leases expire and they sign new ones. For those who seek to rent an apartment, those rents should be a little lower now.
So why aren’t people in a more optimistic mood? The answer is that prices on almost everything went up and are likely to stay up regardless of what the current inflation rate is (although as mentioned, home and rental prices are expected to decline). Going back to 2019, before Covid hit, prices are up a staggering 19.4%. And while income also increased, Americans have not gotten ahead on average. This has been especially pronounced during the last two years, when price hikes outpaced income growth for much of 2022 and 2023.
Perhaps the FED has one more trick up its sleeve – bringing prices down to where they were a couple of years ago. We can only hope.