In light of the massive rise in prices in the country, the US Federal Reserve is initiating a fundamental change in monetary policy and is raising its key interest rate for the first time in more than three years. As the Fed announced after a regular meeting of its interest rate policy committee Wednesday night in Washington, the so-called overnight target range is now 0.25 to 0.5 percent, and thus , a quarter of a percentage point more than in previous months. The time of the corona-related zero interest rate phase and the economic stimulus is coming to an end.
According to the central bank, the goal of the step is to curb inflation in the US, which at 7.9 percent had recently risen to its highest level in 40 years. A written statement from the Fed said that the economic situation in the United States had continued to improve in recent weeks, as had the situation in the labor market. However, Russia’s attack on Ukraine will further increase pressure on prices and weigh on the development of the economy.
With the overnight money target range, the Federal Reserve controls the costs that commercial banks charge each other for short-term lending transactions. It also influences many everyday interest rates, such as those due when buying a car or overdrawing an account. An increase of a quarter point initially has no direct consequences for economic and price developments, especially since increases in official interest rates always become effective with a delay of at least six months. However, it is a clear signal to consumers, businesses and politicians that, after months of hesitation, the central bank is now taking the risk of inflation seriously and is ready to take further action. Before Russia attacked Ukraine, some US experts expected as many as seven increases for this year alone.
As in Germany, the rate of inflation in the US has recently skyrocketed almost unchecked due to coronavirus-related delivery bottlenecks around the world. In February it was 7.9 percent, four times the Fed’s target and the highest level since 1981. It is likely to rise to higher in the coming months amid the war in Ukraine and myriad other economic disruptors than the ten percent possible.
Fear of a spiral of prices and wages
However, the even bigger problem for the Fed is that, unlike in Europe, inflation in the US has now reached almost every sector of the economy and has also resulted in significant wage increases. This threatens the so-called wage-price spiral, which central bankers around the world fear because it can often only be stopped by massive interest rate hikes and accepting a severe recession.
To avoid such a scenario, the Fed is now attempting small rate hikes that are intended to signal its resolve to citizens, businesses, and financial markets. Increases in key interest rates make loans more expensive, for example for investments or to build a house, and thus dampen the economy. The idea is that if demand for construction and other services falls, pressure on prices will also fall, and the inflation rate will fall back to the level of around 2 percent that the central bank considers ideal in the medium term. However, it is not clear whether the US monetary authorities’ concept will work.
The decisions of Fed Chairman Jerome Powell and his colleagues could also backfire in light of the myriad disruptive factors currently affecting the global economy, or they could achieve the opposite of what is desired. If, for example, the Ukraine war drags on for months or if stock markets crash massively, central bankers could cripple the economic engine by raising interest rates too quickly at the very moment it is already sputtering. At worst, Powell and his colleagues would trigger the very recession they want to avoid. The big bank Goldman Sachs, for example, already estimates the probability of a recession in the US next year, despite the current good growth figures, at up to 35 percent.