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If you’ve noticed that it now costs more money to take out a personal loan or borrow money via a credit card balance, there’s a reason for that. The Federal Reserve has been hiking up interest rates since early 2022 in an effort to cool inflation. As a result, the general cost of borrowing has risen.
But why does the Fed care so much about inflation anyway? And why is it willing to potentially drive the economy into a recession just to cool inflation down?
There are good intentions at play
The role of the Federal Reserve is to control monetary policy in the U.S. and promote a thriving, stable economy. And the Fed feels strongly that 2% inflation is most conducive to that goal.
At 2% inflation, the Fed feels that consumers can spend confidently. The central bank also feels that 2% inflation tends to contribute to healthy levels of employment.
Meanwhile, in April, annual inflation was measured at 4.9%, according to that month’s Consumer Price Index. So clearly, we’re not where the Fed wants us to be with regard to inflation. And that’s why the Fed has been so insistent about raising interest rates.
It’s not as if the Fed wants to punish consumers by making the cost of borrowing so expensive. And the Fed’s goal certainly isn’t to fuel a recession and drive unemployment levels upward.
Rather, the Fed feels strongly that in the long run, 2% inflation is best to target. And so it’s trying to do what it can to get us back there.
Let’s remember that right now, because of rampant inflation, many Americans are struggling to pay their basic bills. Some are having trouble keeping up with their mortgage payments. Others are having a hard time putting food on the table. Lower inflation could ease that strain for a lot of people.
Will interest rate hikes lead to a recession?
Unfortunately, there is that potential. If consumers grow tired of sky-high interest rates, their spending might decline until borrowing costs come down. If consumer spending drops to a notable degree, it could be enough to fuel a recession.
Of course, the Fed’s hope is that consumers will pull back on spending just enough to ease inflation, but not so much as to drive the economy into a recession. Whether that happens is yet to be determined.
But to be clear, not every economic recession is horrendously painful and drawn-out. There is such a thing as a mild recession — and that’s what the Fed is telling American consumers to expect in the near term.
Now, this doesn’t mean that a mild recession won’t lead to an uptick in unemployment and bring about other unfavorable consequences. But it’s also fair to say that at this point, consumers have been duly warned.
Boosting your savings account balance, in fact, would be a smart thing to do right about now. We don’t know what the Fed’s policy will be for the remainder of 2023 with regard to interest rate hikes. But if the Fed opts to raise rates again this year, it could lead us closer to the economic slowdown nobody wants.
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