Federal Reserve chair Kevin Warsh has raised interest rates after facing pressure from markets, because that’s what markets expect the Fed chair to do when inflation data comes in hot. Personal consumption expenditure (PCE) inflation has been above 3 percent since March of this year, and rising prices are straining workers’ and their families’ budgets. But if we think through the mechanism by which raising interest rates is supposed to tamp down on inflation, alongside what factors we can observe to be the cause of inflation today, using the interest rate as a tool for fighting inflation does not make sense here. Moreover, the consequences of a rate hike could fall heaviest on American families barely getting by, while benefitting those least in need of the extra help.
The Fed funds rate, the interest rate at which banks lend cash to each other, is the benchmark against which the interest rates for all other loans throughout the economy are set. But it does not reach all borrowers equally or at the same speed. Credit cards and home equity lines of credit reprice within weeks of a Fed move. Rates on new mortgage and auto loans also move, though indirectly through Treasury yields, and typically by less. The result is that the immediate cost of a rate hike falls on borrowers carrying revolving balances, first-time homebuyers, and workers who need to finance a car to get to a job. These are the families who see a Fed hike on their next statement.
Hiking interest rates is a broad-based, non-targeted approach to addressing inflation. When hiking the interest rate works, it does so by making money more expensive to borrow. More expensive cash lowers the rate of investment and household debt acquisition, and eventually reduces consumer spending through increased unemployment, reducing the overall level of economic activity across the board. With fewer buyers in the market, the hope is that sellers in the aggregate (of all things: goods, services, and labor alike) will lower their expectations and slow the rate at which they attempt to raise their prices (or, in some cases, offer discounts).
The process I just described relies on a crucial assumption to be effective: that the reason prices are rising is as diffuse across the economy as the proposed solution would be. Increasing the cost of money everywhere makes sense in a world where prices are rising because money got too cheap. That calls for a moment of belt tightening, or sobering up by “taking away the punch bowl.”
But is the problem with the American economy really that workers and their families have gotten too reckless with their spending? Does the average American household really need more economic discipline from the market? Wage growth hasn’t kept pace with inflation, and the labor share of GDP has just fallen to its lowest level on record. Incomes have increased at the median, but rose fastest and furthest for those at the top, while those at the bottom saw little change at all. The overall unemployment rate remains locked at just above 4 percent, but unemployment disparities persist throughout the economy such that the Black unemployment rate is 6 percent—a rate white workers rarely experience outside of recessions.
There is a world, in theory, where the overall price level increases because workers have enough power to bid up their wages so fast that firms have to raise prices to stay in business; or where credit is simply too easy to access, leading to a recklessness among consumers and investors that inflates product and asset prices alike (ironically, much of the 2010s can be characterized as a cheap credit environment where inflation was stubbornly low). It’s safe to say we don’t live in that world.
Here in the real world, we know that prices throughout the economy are rising in large part because of reckless policy choices by the executive branch, and perhaps by irrational overinvestment in one sector rather than economywide. We know that, for example, our current regime of erratic (and largely illegal) tariffs have led directly to rising prices both directly due to producers paying increased import costs and through added costs associated with uncertainty.
We also know that our ill-defined conflict with Iran and the subsequent closure of the Strait of Hormuz have increased the price of fuel and fertilizer globally—direct inputs in the production of nearly every product through the embedded cost of transporting said products. Inflation began to rise significantly in the month following the start of the conflict this year. Prior to the Iran conflict, year-on-year PCE inflation had not been above 3 percent since October 2023. The Biden administration had effectively steered the economy out of the severe supply constraints of the global COVID-19 pandemic; the Iran conflict meanwhile has directly led to an acceleration in prices increasing.
There are effective solutions to the problem of persistent inflation due to shortages. They start with establishing and maintaining stable trade relationships with allies and partner nations, to help secure expectations and reduce market uncertainty. This of course includes refraining from international conflicts that lead to disrupted supply-chains.
Effectively fighting persistent inflation requires thoughtful and strategic industrial policy in the long-term. It means developing robust supply chains with enough redundancies to withstand potential disruptions. In the case of fuel, that means investing in alternative, renewable energy sources and infrastructure. There is even a role for strategic tariff policy here, though one directed at intentionally growing viable American industries rather than as a political bludgeon used against our enemies (and somehow our allies).
Moderately raising interest rates now will likely not send the economy into an immediate recession. But the question becomes, at a time when Americans are increasingly drowning in debt, in whose interest is it to see rates on mortgages, credit cards, and auto loans increase? Does it help the American family struggling with grocery bills to see credit become more expensive? If the unemployment rate does rise—as intended by a rate hike—on which households will that burden fall? Almost certainly on those fighting hardest to get by. It is unconscionable to ask already constrained American workers to tighten their belts further while the executive branch makes no attempt to restrain its careless actions whatsoever.
Tags: interest rates, inflation, federal reserve
A Hike in Whose Interest?
Federal Reserve chair Kevin Warsh has raised interest rates after facing pressure from markets, because that’s what markets expect the Fed chair to do when inflation data comes in hot. Personal consumption expenditure (PCE) inflation has been above 3 percent since March of this year, and rising prices are straining workers’ and their families’ budgets. But if we think through the mechanism by which raising interest rates is supposed to tamp down on inflation, alongside what factors we can observe to be the cause of inflation today, using the interest rate as a tool for fighting inflation does not make sense here. Moreover, the consequences of a rate hike could fall heaviest on American families barely getting by, while benefitting those least in need of the extra help.
The Fed funds rate, the interest rate at which banks lend cash to each other, is the benchmark against which the interest rates for all other loans throughout the economy are set. But it does not reach all borrowers equally or at the same speed. Credit cards and home equity lines of credit reprice within weeks of a Fed move. Rates on new mortgage and auto loans also move, though indirectly through Treasury yields, and typically by less. The result is that the immediate cost of a rate hike falls on borrowers carrying revolving balances, first-time homebuyers, and workers who need to finance a car to get to a job. These are the families who see a Fed hike on their next statement.
Hiking interest rates is a broad-based, non-targeted approach to addressing inflation. When hiking the interest rate works, it does so by making money more expensive to borrow. More expensive cash lowers the rate of investment and household debt acquisition, and eventually reduces consumer spending through increased unemployment, reducing the overall level of economic activity across the board. With fewer buyers in the market, the hope is that sellers in the aggregate (of all things: goods, services, and labor alike) will lower their expectations and slow the rate at which they attempt to raise their prices (or, in some cases, offer discounts).
The process I just described relies on a crucial assumption to be effective: that the reason prices are rising is as diffuse across the economy as the proposed solution would be. Increasing the cost of money everywhere makes sense in a world where prices are rising because money got too cheap. That calls for a moment of belt tightening, or sobering up by “taking away the punch bowl.”
But is the problem with the American economy really that workers and their families have gotten too reckless with their spending? Does the average American household really need more economic discipline from the market? Wage growth hasn’t kept pace with inflation, and the labor share of GDP has just fallen to its lowest level on record. Incomes have increased at the median, but rose fastest and furthest for those at the top, while those at the bottom saw little change at all. The overall unemployment rate remains locked at just above 4 percent, but unemployment disparities persist throughout the economy such that the Black unemployment rate is 6 percent—a rate white workers rarely experience outside of recessions.
There is a world, in theory, where the overall price level increases because workers have enough power to bid up their wages so fast that firms have to raise prices to stay in business; or where credit is simply too easy to access, leading to a recklessness among consumers and investors that inflates product and asset prices alike (ironically, much of the 2010s can be characterized as a cheap credit environment where inflation was stubbornly low). It’s safe to say we don’t live in that world.
Here in the real world, we know that prices throughout the economy are rising in large part because of reckless policy choices by the executive branch, and perhaps by irrational overinvestment in one sector rather than economywide. We know that, for example, our current regime of erratic (and largely illegal) tariffs have led directly to rising prices both directly due to producers paying increased import costs and through added costs associated with uncertainty.
We also know that our ill-defined conflict with Iran and the subsequent closure of the Strait of Hormuz have increased the price of fuel and fertilizer globally—direct inputs in the production of nearly every product through the embedded cost of transporting said products. Inflation began to rise significantly in the month following the start of the conflict this year. Prior to the Iran conflict, year-on-year PCE inflation had not been above 3 percent since October 2023. The Biden administration had effectively steered the economy out of the severe supply constraints of the global COVID-19 pandemic; the Iran conflict meanwhile has directly led to an acceleration in prices increasing.
There are effective solutions to the problem of persistent inflation due to shortages. They start with establishing and maintaining stable trade relationships with allies and partner nations, to help secure expectations and reduce market uncertainty. This of course includes refraining from international conflicts that lead to disrupted supply-chains.
Effectively fighting persistent inflation requires thoughtful and strategic industrial policy in the long-term. It means developing robust supply chains with enough redundancies to withstand potential disruptions. In the case of fuel, that means investing in alternative, renewable energy sources and infrastructure. There is even a role for strategic tariff policy here, though one directed at intentionally growing viable American industries rather than as a political bludgeon used against our enemies (and somehow our allies).
Moderately raising interest rates now will likely not send the economy into an immediate recession. But the question becomes, at a time when Americans are increasingly drowning in debt, in whose interest is it to see rates on mortgages, credit cards, and auto loans increase? Does it help the American family struggling with grocery bills to see credit become more expensive? If the unemployment rate does rise—as intended by a rate hike—on which households will that burden fall? Almost certainly on those fighting hardest to get by. It is unconscionable to ask already constrained American workers to tighten their belts further while the executive branch makes no attempt to restrain its careless actions whatsoever.
Tags: interest rates, inflation, federal reserve