Federal Reserve Chairman Jerome Powell speaks at a news conference following a Federal Open Market Committee meeting on May 4, 2022 in Washington, DC.
Win McNamee | Getty Images
The Federal Reserve looks set to raise its benchmark rate again today, and may even hand out the first three-quarter-point hike in 28 years.
The central bank is likely to raise its target federal funds rate again to address the worst inflation in about 40 years.
It may move fast and raise interest rates by 75 basis points instead of 50 basis points, as was the previous expectation, because inflation has remained high. A basis point is equal to 0.01%.
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In May, inflation rose 8.6%, more than analysts expected and at the fastest clip since 1981. Yet consumers who are already grappling with higher prices putting a strain on their wallets may be wondering how increasing borrowing costs will help tamp down inflation.
“This is something really hard for the typical consumer to understand, seeing these fast price raises that are so unfamiliar to large parts of our population who haven’t seen inflation rates like this before,” said Tara Sinclair, a senior fellow at the Indeed Hiring Lab. “And then trying to figure out the Fed’s complicated role in all of this is very confusing.”
Here’s what you need to know.
The Fed’s main tool to battle inflation is interest rates
That higher rate influences the interest you pay on everything from credit cards to mortgages to car loans, making borrowing more expensive. On the flip side, it also boosts rates on savings accounts.
How raising rates can slow inflation
The Fed wants to avoid stalling the economy
Of course, it will take some time for any action to affect the economy and curb inflation. That’s why the Federal Open Market Committee carefully watches economic data to decide how much and how frequently to raise rates.
There is also some uncertainty due to the war in Ukraine, which has also increased prices on commodities such as gas. The Fed will have to watch how the war is hampering the U.S. economy and act accordingly.
It might get worse before it gets better
Of course, ideally, the central bank would like to raise rates gradually so that the economy slows just enough to bring down prices without creating too much additional unemployment. The Fed wants to avoid a recession as well as the chance of stagflation — a situation in which inflation remains high while the economy slows.
“They have to carefully walk that tightrope,” said Sinclair.
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Source: https://www.cnbc.com/2022/06/15/federal-reserve-interest-rate-hike-how-raising-rates-slows-inflation.html