4 things to know as the Fed begins its biggest fight against inflation in years

4 things to know as the Fed begins its biggest fight against inflation in years

4 things to know as the Fed begins its biggest fight against inflation in years

Federal Reserve Chairman Jerome Powell retrieves his notebooks as he testifies before the Senate Banking Committee on March 3. The Fed is expected to raise interest rates by half a percentage point at its meeting this week.

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Federal Reserve Chairman Jerome Powell retrieves his notebooks as he testifies before the Senate Banking Committee on March 3. The Fed is expected to raise interest rates by half a percentage point at its meeting this week.

Jonathan Ernst/Pool/Getty Images

The Federal Reserve is about to deliver its biggest punch yet in the fight against soaring inflation.

Policymakers begin a two-day meeting on Tuesday, and are widely expected to hike interest rates by half a percentage point — the biggest rate hike in more than two decades.

It’s a clear sign of the urgency with which the Fed is tackling inflation, as prices continue to climb at the fastest pace in 40 years.

And the Fed will not end there. The central bank is expected to continue raising borrowing costs in the coming months.

Here is a brief overview of the Fed’s battle plan.

Why is the Fed raising interest rates?

The central bank fears prices are rising too quickly as people continue to spend money, whether it’s shopping or booking long-delayed vacations.

The demand is so strong that it exceeds what companies can supply, given that global supply chains are still fragile and employers still struggle to find enough workers.

A key Commerce Department metric last week showed prices jumped 6.6% in the 12 months to March. That’s more than three times the Fed’s inflation target and the biggest price increase since 1982.

The Fed hopes to dampen demand and dampen inflation by making borrowing more expensive.

The Fed raised interest rates by a quarter of a percentage point in March, and it is expected to follow up this week with its first half-point rate hike since 2000.

Grocery prices jumped as inflation hit its highest level in four decades. Here, prices are displayed at a supermarket in Rosemead, California on April 21.

Frederic J. Brown/AFP via Getty Images


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Grocery prices jumped as inflation hit its highest level in four decades. Here, prices are displayed at a supermarket in Rosemead, California on April 21.

Frederic J. Brown/AFP via Getty Images

How much will the Fed raise interest rates?

Potentially many more.

Experts say interest rates may need to rise significantly to reduce demand after the Fed kept borrowing costs at low levels for much of the coronavirus pandemic.

On average, Fed policymakers said at their March meeting that rates are expected to rise nearly 2 percentage points this year, with further rate increases next year.

Fed Chairman Jerome Powell said the central bank would closely monitor the performance of the economy and adjust the pace of rate hikes if necessary.

But Powell thinks the Fed’s usual practice of raising rates a quarter point at a time might not be enough. He suggests that the central bank should act aggressively from the start and then reassess if necessary.

“It is appropriate, in my opinion, to act a little faster,” Powell told an International Monetary Fund forum last month. “I also think there’s something to the idea of ​​front-loading whatever accommodation you think is appropriate.”

How will rising borrowing costs affect the economy?

Rising interest rates make it more expensive to take out a car loan or carry over a credit card balance.

They also increase the cost of buying a house. Mortgage rates have already climbed above 5% in anticipation of Fed actions, from below 3% a year ago. This adds about $370 to the monthly payment for a home at the median price.

Airline passengers prepare to enter a security checkpoint at San Francisco International Airport on April 19.

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Airline passengers prepare to enter a security checkpoint at San Francisco International Airport on April 19.

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The Fed’s intention in raising rates is to discourage spending just enough to bring inflation down, without tipping the economy into recession – what economists call a “soft landing.”

“That’s our goal,” Powell said. “I don’t think you’ll hear anyone at the Fed say it’s going to be simple or straightforward.”

Some analysts are skeptical of the central bank’s ability to strike this delicate balance, having waited for inflation to climb so high.

They warn that the kind of aggressive action that is now needed to control prices is likely to trigger an economic downturn. Deutsche Bank, a German lender and major Wall Street firm, last week predicted a “major recession” next year.

These concerns contributed to last week’s sharp sell-off in the stock market.

What other actions is the Fed taking?

In addition to raising interest rates, the Fed is expected to announce its intention to gradually reduce the collection of government bonds and mortgage-backed securities it purchased during the pandemic.

Purchasing these bonds helped pump money into the economy and kept borrowing costs low. Reducing Fed holdings should have the opposite effect: curb demand and help curb inflation.

“It’s a secondary tool, but it takes a lot of liquidity and housing out of the system,” said Kathy Bostjancic of Oxford Economics.

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