The Federal Reserve raised interest rates by a quarter percentage point on Wednesday in an effort to slow accelerating inflation, marking the first time the central bank has used this tool this year.
Fed Chair Kevin Warsh stated during a news conference that the plain fact is that inflation is too high and has been for too long
. According to Warsh, inflation has remained above the Federal Reserve’s 2% target for five years. The central bank indicated it lacks confidence that inflation would cool without the implementation of higher rates.
Warsh argued that the current economy is strong enough to absorb the impact of the hike, which he described as modest. He noted that the job market is on solid footing to handle higher borrowing costs without causing a surge in layoffs, and consumer spending has continued to grow despite households being pinched by higher prices.
Impact on Borrowing Costs
While the Federal Reserve does not directly control the rates that firms charge for credit cards or mortgages, it intends for its own rate increase to create a domino effect that raises borrowing costs across the economy.
The impact is already appearing in the housing market. Data released Thursday by Freddie Mac showed the average rate for a 30-year fixed rate mortgage rose to 6.95% this week, an increase of almost two-tenths of a percent from the previous week. Kara Ng, a senior economist at Zillow, compared the situation to the movie The Godfather, stating, Everytime it tries to break out, something pulls it back in
, referring to the stagnant housing market. This increase can raise the monthly cost of a standard home loan by hundreds of dollars.
Other forms of debt are also affected, though to a lesser extent than mortgages. Higher interest rates trickle down to Buy Now Pay Later
deals and credit card balances. Analysts at the online loan marketplace LendingTree estimate that for an individual with $7,000 in credit card debt, the recent rate hike would result in an additional cost of only a few dollars per month.
The Federal Reserve’s Economic Strategy
The interest rate is considered the most important tool in the Federal Reserve’s toolkit for influencing the economy. When inflation is high, the Fed typically raises rates to slow it down.
This strategy is the opposite of the approach taken during the Covid-19 pandemic. At that time, the Fed was led by Jerome Powell, who slashed interest rates to near zero to encourage spending and prevent massive layoffs by prompting financial firms to lower costs for mortgages and loans. While that approach was successful, the Fed eventually had to reverse course as inflation began to climb.