In 2021, the Federal Reserve dismissed price increases as temporary, but began raising interest rates in March of that year. This was a departure from their previous approach, as the Fed had not raised rates more than a quarter point at a time in over two decades.
Since then, they have increased rates more aggressively, with four increases of 0.75 percentage points.
On Wednesday (yesterday), the Federal Reserve raised its benchmark interest rate to the highest level in 15 years, indicating that the fight against inflation is not yet over despite some recent promising signs.
As expected, the rate-setting Federal Open Market Committee voted to increase the overnight borrowing rate by half a percentage point, bringing it to a targeted range of 4.25% to 4.5%.
This marks a break from the previous four consecutive hikes of three-quarter points, the most aggressive such policy moves since the early 1980s.
In addition to the interest rate increase, officials indicated that they expect to keep rates higher throughout next year, with no reductions until 2024.
The expected “terminal rate,” or the point at which officials expect to end the rate hikes, was stated as 5.1% according to the FOMC's “dot plot” of individual members' expectations.
At the news of the expected longer period of higher interest rates, investors initially reacted negatively and stocks lost their earlier gains.
Chairman Jerome Powell emphasized the importance of continuing to fight against inflation in order to prevent the expectation of higher prices from becoming ingrained.
“Inflation data received so far for October and November show a welcome reduction in the monthly pace of price increases,” Powell said at the post-meeting news conference. “But it will take substantially more evidence to have confidence that inflation is on a sustained downward path.”
The Fed has just reached the highest level of the fed funds rate since December 2007, when they were implementing policies to combat the global financial crisis. Now, they are raising rates in anticipation of a slow economy in 2023.
The members of the organization agreed to gradually increase the funds rate until it reaches a median level of 5.1% in the next year, which is equivalent to a target range of 5%-5.25%. Once this is reached, officials plan to pause to allow the effects of the monetary policy tightening to be felt in the economy.
The consensus then indicated that there will be a full percentage point worth of rate cuts in 2024, bringing the funds rate to 4.1% by the end of that year. This will be followed by another percentage point of cuts in 2025 to a rate of 3.1%, before the benchmark settles into a longer-term neutral level of 2.5%.
The latest dot plot showed a high degree of uncertainty among members about the future trajectory of interest rates. Several members predicted that rates would rise significantly higher than the median projections for 2023 and 2024.
Specifically, 7 of the 19 members (voters and non-voters alike) anticipated rates above 5.25% in 2023, and 7 members predicted rates above the median 4.1% in 2024. This suggests that members are unsure about how to handle the challenging inflation environment, which is the worst the economy has seen since the early 1980s.
The FOMC policy statement, which was approved unanimously, was largely unchanged from the previous meeting in November. Some had anticipated that the Fed would modify its language to be less committal on the issue of “ongoing increases,” but the phrase remained in the statement.
Fed officials believe that raising interest rates can help to control the amount of money in the economy, reducing demand and ultimately bringing down prices after inflation reached its highest level in over 40 years.
The FOMC lowered its growth projections for 2023, putting expected GDP gains at just 0.5%, which is barely above the level that would be considered a recession. The GDP outlook for this year was also revised to 0.5%. In the September projections, the committee had expected 0.2% growth this year and 1.2% next.
The committee raised its median estimate for its favored core inflation measure to 4.8% for 2022, an increase of 0.3 percentage points from the September outlook.
Members slightly lowered their unemployment rate outlook for this year and bumped it higher for the subsequent years.
The rate hike follows consecutive reports indicating progress in the fight against inflation.
However, all of the recent readings remain well above the Federal Reserve's 2% target, and officials have stressed the need to see consistent declines in inflation. Powell said the recent news was welcome, but he still sees services inflation as too high.
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