Why is the Fed raising interest rates?

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Why is the Fed raising interest rates?

Prices for groceries, couches and rent are climbing rapidly, and Federal Reserve officials are eyeing that trend. On Wednesday, he is expected to take his biggest step toward counteracting it.

Central bank officials – who have been indicating for months that they are preparing to withdraw economic support – are expected to increase their policy interest rate by a quarter percentage point. That small change will carry with it a big signal. Policy makers are telling the markets and the public that they are in full-blown inflation-fighting mode and it is necessary to ensure that price gains do not remain hot for months and years to come.

The Fed will issue its decision at 2 p.m., and central bank chairman Jerome H. Powell will hold a news conference at 2:30 p.m.

The Fed is operating at a stressful moment for many consumers, when people are worrying about rising day-to-day expenses and trying to imagine what higher interest rates could mean for their finances. Is. Here’s a rundown of what’s happening, why it’s happening, and what it means for markets and the economy.

The Fed is set to raise the federal funds rate, a short-term borrowing cost for banks, in what officials have indicated will be the first of a steady series of moves. Fed policy changes through other types of interest rates – on mortgages, car loans and credit cards. Some of the interest rates that consumers pay to borrow have already risen higher in anticipation of the Fed’s impending adjustments.

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The Fed will preview expected growth in borrowing costs in 2022 and 2023 in a fresh summary of economic projections, a quarterly release that will accompany the March statement. Investors expect seven rate hikes this year, which will take the fund’s rate above 1.75 percent.

The policy changes come at a challenging moment for central bankers: They are in charge of maintaining price stability, and inflation is at its fastest pace in four decades. While officials expect prices to rise marginally this year, how quickly and by how much is uncertain, especially as the war in Ukraine raises fuel costs and fresh virus restrictions in China are expected to cause supply chain disruptions. There is danger.

The Fed is also in charge of promoting maximum employment, but with hiring faster and more open jobs than available workers, that goal appears to have been achieved, at least for now.

The idea behind raising rates is simple: Higher borrowing costs can slow inflation by reducing demand. When it costs more to borrow, fewer people can buy homes and cars, and fewer businesses can expand or buy new machinery. Expenses pull back. Because of less activity, companies need fewer employees. Low demand for labor leads to a slow rise in wages, which further cools demand. Higher rates effectively pour cold water on the economy.

The effect of higher rates can be seen in the markets. Higher interest rates ultimately drive down stock prices—in part because it costs businesses more to operate when it’s expensive to borrow money, and partly because the Fed is on track to touch a slowdown in rate hikes. record, which is terrible for stocks. Precious borrowing costs also weigh on the value of other properties, such as houses, as buyers shy away from the market.

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The Fed is also preparing to reduce its balance sheet of bond holdings, and many economists expect Fed officials to issue a plan to do so as soon as May. This could push up longer-term rates and possibly lead to further decline in stock, bond and house prices.

You might wonder why the Fed wants to slow down the economy and damage the stock market. The central bank wants a strong economy, but stability is the name of the game: A little pain today may be less pain tomorrow.

The Fed is trying to bring inflation down to a more comfortable level – where price increases do not affect people’s spending choices or daily lives. Officials hope that if they can slow inflation down to slow the economy, without damaging it so much that it leads to a recession, they can set the stage for a long and steady expansion.

“I think it’s more likely what we call a soft landing,” Mr. Powell said during recent testimony before lawmakers.

The Fed has eased the economy before: it raised rates in the early 1990s without sending unemployment higher, and it appeared to be in the process of achieving a soft landing before the pandemic struck, between 2015 and 2018. rates increased.

But economists warn that pulling it off this time may be a difficult task.

Donald Kohn, former Fed vice chairman, said of the soft landing, “I wouldn’t rule it out.” But he added that it is also possible to tighten the noose on the demand which further increases unemployment.

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