Although we have seen our gas gradually return to normal over the past few months, inflation in the United States still increased in August according to the Bureau Labor of Statistics. In order to counter these rising prices, the Federal Reserve made its toughest policy decision since the 1980s to fight inflation.
USC Economics Ph.D candidate, Dario Laudati breaks down the relationship between inflation rates and interest rates in this policy decision.
Dario Laudati: “You have to think at the interest rates as the cost of money. So the Federal Reserve cannot affect the economy directly. It has to go through the financial system. So the Fed tries to affect the real economy through the financial system. Now, what’s happening at the moment is that the Fed is very much scared of the inflation of the inflation dynamics in order to lower this inflation rate. They are trying to make money more costly so that banks issue lower allure amount of loans. And by doing so, the economy cools down.”
According to Laudati, The Fed has taken a demand-centered approach in making this decision, as its main focus remains to decrease consumer spending to get inflation back down to their mandated average of 2%.
Dario Laudati: “Right now the Fed is thinking there is too much employment. People are working too much. There are not enough people to fill the gaps of the job that get created from firms. So they’re actually trying to almost generate more layoffs in order for people to have less spending and come down and have the practice coming down.”
As announced by the Chair of the Fed, Jerome Powell, the Federal Open Market Committee intends on continuing a further trend in increasing interest rates.
Jerome Powell: “Today, the FOMC raised its policy interest rate by 3/4 percentage point, and we anticipate that ongoing increases will be appropriate. We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2 percent.”
Dario Laudati expresses concern about what this trend will mean for American consumers, especially for those who are low-income.
Dario Laudati: “The Fed didn’t simply raise rates yesterday. They went further and they said they are committed to keep doing this. That’s crucial. Sometimes the Fed does this so called “Fed speak.” So what happens is that if you have a higher cost of inputs, you have to reassess your risks. What does it mean in plain terms? You have to avoid giving credit to people that are more risky to you. Who are the people that more risk to you? The poorest. So potentially there will be the poorer parts of the population that we have not to credit or will have a cost of credit which is exorbitant . In the medium run, it’s very likely that there would be a recession.”
Should the Fed keep its word that consecutive bumps in inflation should be expected, the cost will be paid by consumers.
For Annenberg Media, I’m Kassydi Rone.