How The Fed’s Monetary Policy Has Raised Inflation For Some Americans

The Fed has a hard job ahead fighting inflation.

But its recent series of interest rate hikes have delivered a substantial increase in the cost of living for more than a few Americans. That’s at odds with the institution’s stated goals.

September’s inflation reading hit 8.2% up from 6.2% in October 2021. That we already now. But depending on who you are, the CPI may not reflect the total situation.

The shelter, or cost of housing, component of inflation used in the Consumer Price Index (CPI) doesn’t include information on homebuyers who have borrowed using adjustable rate mortgages (ARM.) That means anyone who took out an ARM will more than likely have seen a jump in their monthly cost of living. In other words, inflation is higher for this group.

Some people mistakenly believe that the CPI is inflation. It isn’t. It is a measure of inflation, and like all metrics it is flawed. There is no way it can accurately reflect the situation for every American including the substantial group of people who borrow using ARMs.

Those borrowers get a fixed interest rate for the first few years of an ARM. But after that the mortgage cost fluctuates for the rest of the loan’s term. Those fluctuating interest rates typically track short-term government borrowing costs plus a small margin to reflect higher risks.

So far this year the Fed has increased its Fed Funds rate four times to 3.25% recently from less than half a percent in February.

At the same time, the borrowing cost on ARMs more than doubled to 5.7% recently up from 2.4% at the beginning of the year. While anyone who is still benefiting from the fixed period won’t be feeling the impact of rising rates, others will.

Using that jump in ARM rates as a proxy for what would happen to monthly mortgage payments, we can see that many people with outstanding ARM home loans will likely be seeing huge increases in the cost of their housing. Put another way, their monthly cost of shelter may have more than doubled in less than a year.

Whether or not that figure is included in the CPI, it is still a jump in inflation. And there’s the rub for the Fed. Every time it raises interest rates that will lift the immediate housing costs facing a slew of the homeowners of America.

Eventually, the price of houses will fall as demand for homes drops which would help alleviate the inflation problem. But in the short term that won’t happen. Over the next few months, what the Fed has done is to increase inflation further rather than curb it, at least for a part of the housing market. In short, the Fed is doing something that results in the opposite of what it says it wants.