Anyone with a long enough memory should view Wednesday’s interest rate increase the way a sailor sees a rapidly falling barometer.
Batten the hatches. The smooth sailing is over.
Way back when MTV actually showed music videos, inflation was running at an eye-popping 15% and the Federal Reserve took an ultra-hard line on rates to get prices under control.
The Fed’s action helped spark a recovery and stock market boom, but not before a nasty recession and considerable hardship with higher borrowing rates for automobiles, homes and credit card debt. If you want a “back-in-the-day” story, ask someone who graduated from college in the late 1970s about his or her very first home mortgage.
On Wednesday, the Federal Open Market Committee advanced its own muscular approach to taming inflation. On the heels of a disappointing inflation report, the Fed raised its benchmark federal funds rate three-quarters of a percentage point and signaled that there’s more to come.
The federal funds rate, which influences many consumer and business loans, could stand at 4.5% by 2023. That’s a far cry from 20.61% in 1981, but it hasn’t been this high since 2007 when the Fed embarked on easy money policies to combat the housing collapse of 2008 and then the economic fallout from the pandemic.
The scary thing about this week’s rate hike is that it’s unclear if we’re at a point like 1981 and there’s light at the end of the tunnel. (Inflation was down to 4% by 1983). Recent history is not encouraging. The Arab oil embargo sent fuel prices soaring in 1973 and 1974, but inflation was still running at double digits six and seven years later.
That’s why the August report showing an 8.3% year-over-year spike in prices was so troubling. Gasoline prices had dropped from early summer highs, but the report showed the core inflation rate, which excludes food and energy, rose 6.5% annually. Year-over-year increases were 10% for household furnishings, 8% for used cars, 7% for overall services and 5.6% for medical care.
This suggests that inflation can’t be blamed strictly on Ukraine or supply chain disruptions but is instead getting embedded into every facet of the economy. If it isn’t 1981 but maybe 1978, then there are indeed rough seas ahead.
Both the Biden administration and the Fed contributed to this mess with monetary and fiscal policies that assumed that free money was free. It isn’t, and Wednesday’s policy statement from the Fed should make that clear, especially to consumers and businesses that are heavily indebted. But really, all Americans will pay because a growing slice of the federal budget will be devoted to debt repayment instead of defense, education or other priorities.