By Gabriela Mullen
Rising prices due to inflation have been under scrutiny lately, mainly due to the economic decline following the onset of the Covid 19 pandemic in March of 2020. However, the most recent official annual inflation rate released in March 2022 is 8.5%, placing the United States inflation rate at the highest it’s been since December 1981 (U.S. Bureau of Labor Statistics). This prompted the Federal Reserve System to raise interest rates for the first time since December 2018, before the pandemic began and the US faced its subsequent financial consequences. That rate increase, though, was on a much smaller scale both in the interest rate change and the severity of the inflation rate. The inflation rate decreased from 2.44% in 2018 to 1.88% in 2019 (U.S. Bureau of Labor Statistics), likely in response to that interest rate increase.
On March 21, 2022, Federal Reserve Chairman Jerome Powell called for a more dramatic increase in interest rates to combat inflation, in addition to the increase in early March (The Wall Street Journal). Powell cited the Biden administration as contributing to inflation, particularly the recent demand for durable goods, along with Russia’s declaration of war on Ukraine. This uptick in durable goods is clearly associated with the normalization of remote work, as workers who once left the home everyday for the office are now spending more time in the home and requiring more home office space and paraphernalia. While this phenomenon has been occurring for 2 years now, the invasion of Ukraine in February served as a sudden and severe shock to the economy, forcing the inflation rate up. This was likely the main catalyst in Powell’s new plan for interest rates.
While the Fed’s current plan is to raise rates in a staggered system by only a quarter-point, which is typically how fast they are changed, the chairman did suggest that increasing the rate by a more controversial half point has been considered and will be implemented if deemed necessary (Rugaber). In theory, raising interest rates should eventually decrease the inflation rate, but if interest rates grow too fast it causes more negative effects than it should have. A quickly increasing interest rate quickly increases the prices of everyday goods, leading people to purchase less and possibly decreasing demand in the economy somewhat dramatically. This could even lead to an increase in the unemployment rate as companies would produce less due to less demand. The unemployment rate is down to 3.6% after a whopping 14.7% two years ago, so taking this factor into account when changing the interest rate is significant (U.S. Bureau of Labor Statistics).
The last time the interest rate was bumped by half a point was over two decades ago, in May of 2000, and before that it had been over five years (CNBC). After this change, the inflation rate did in fact go down from 3.36% in 2000 to 2.85% in 2001 (U.S. Bureau of Labor Statistics), only to be disturbed again by 9/11 later that year. However, during this time period, the unusually high worker productivity likely had an effect on decreasing the inflation rate as well. Technology was booming in the year 2000, making it possible for more work to occur in the same amount of time with the same amount of workers and resources. This allowed businesses to maintain costs and drastically increase output. The most notable example of new technology like this was the popularization of the internet around this time. The casual use of the internet to buy, sell and file revolutionizes the workplace and the home, especially the release of the original iMac computer in August 1998. Another difference in economic circumstances of this time was the relationship between the Federal Reserve System and the executive branch. Powell did not hesitate to reference the Biden Administration and its financial shortcomings, while the half-point increase in 2000 seemed to be completely separate from the presidential administration. In 2000, President Clinton went so far as to say “the Fed will do its job and we will do ours, and I’m going to let them make whatever decision that Chairman Greenspan and the others think is warranted” (CNNMoney), illustrating the hands-off approach that was used then and evidently not used now.
Chairman Powell’s seemingly aggressive approach is likely a reaction to the criticism the Federal Reserve Bank has received over the past two years for not doing enough to cushion the economy and protect the inflation rate. There was talk of the Fed expecting the inflation rate to go down naturally after the pandemic began to dissipate and more Americans became vaccinated against the virus, instead of being proactive and increasing the interest rate or taking other measures before. The recent supply chain crisis associated with production and exportation from China also took a toll on the inflation rate, all unforeseen impacts of the pandemic that lasted longer than many officials thought possible.
Citations
Board, The Editorial. “Opinion | Jerome Powell, Inflation Fighter?” The Wall Street Journal, Dow Jones & Company, 16 Mar. 2022, https://www.wsj.com/articles/jerome-powell-inflation-fighter-federal-reserve-interest-rates-11647468630.
“Covid-19 Causes a Spike in Spending on Durable Goods : Monthly Labor Review.” U.S. Bureau of Labor Statistics, U.S. Bureau of Labor Statistics, https://www.bls.gov/opub/mlr/2021/beyond-bls/covid-19-causes-a-spike-in-spending-on-durable-goods.htm.
“Fed Raises Rates.” CNNMoney, Cable News Network, https://money.cnn.com/2000/05/16/economy/fomc/.
JeffCoxCNBCcom. “Powell Says ‘Inflation Is Much Too High’ and the Fed Will Take ‘Necessary Steps’ to Address.” CNBC, CNBC, 21 Mar. 2022, https://www.cnbc.com/2022/03/21/powell-says-inflation-is-much-too-high-and-the-fed-will-take-necessary-steps-to-address.html.
Rugaber, Christopher, and The Associated Press. “Federal Reserve Will Hike Rates Further If Necessary to Slow Inflation.” Fortune, Fortune, 21 Mar. 2022, https://fortune.com/2022/03/21/federal-reserve-hike-rates-faster-slow-inflation-jerome-powell/.