Five Facts on Inflation and the Federal Reserve
The Big Insight: The Fed may need to go much farther than it has so far in 2022 in raising rates to combat inflation.
In a May 30 Wall Street Journal op-ed, President Biden stated that “the Federal Reserve has a primary responsibility to control inflation” and vowed not to try to “influence its decisions inappropriately” as “past presidents” have done “during periods of elevated inflation.”
The Fed has raised its benchmark range for interest rates twice so far in 2022, and has indicated it will do so several more times before the end of the year. But some experts say the current level of a range of 0.75% to one percent is far too low to significantly impact inflation.
Here are five facts on inflation and the Federal Reserve.
1. The Federal Reserve aims for two percent inflation over the long term. Inflation was 1.8% in 2019, before the coronavirus pandemic — but hit 8.5% in March.
For the past decade, the Fed has set a goal of two percent inflation, saying this level “is most consistent with the Federal Reserve’s mandate for maximum employment and price stability.” When inflation drops below this level, it can weaken the economy; a state of deflation can result in a decline in wages. From 1988 through 2016, annual inflation was 2.2% on average.
2. The Fed has raised interest rates twice so far in 2022, after no increases since 2018.
At the start of the pandemic, the Fed slashed interest rates to confront a quickly tanking economy. At the beginning of March 2020, the Fed’s rate range was 1.5% to 1.75%. By the middle of the month, the Fed had cut the rate range to zero percent to 0.25%. Once the economy began to recover from COVID, the low rates resulted in a surge in inflation. The Fed raised rates in both March and May 2022.
3. Even with recent increases, interest rates remain near their all-time low.
In March, the Fed raised its target rate range 25 basis points, to 0.25% to 0.50%. Then in May, the range was raised 50 basis points to 0.75% to one percent. That most recent hike was the biggest since 2000 — but still left rates far below the three to four percent rates common in most of the first decade of the century.
According to Bankrate, “The federal funds rate — a key borrowing benchmark set by the Federal Reserve — has remained below its historic average for the past 16 years. In fact, the Fed’s key rate spent nine of those years at the rock-bottom level of 0 percent, first from 2008 through 2015, and then from March 2020 to March 2022.”
4. Some economists say interest rates should be raised as high as eight percent in order to truly combat inflation.
St. Louis Fed President James Bullard says rates need to be at least 3.5% by the end of 2022 to combat inflation, while others would go even farther. According to a standard proposed by Stanford economist John B. Taylor, the Fed should raise inflation rates at one and a half times the rate of inflation to keep inflation in check — which would mean rates of six to eight percent.
In 1980, with inflation topping 10%, Federal Reserve Chair Paul Volcker raised rates to 20% in what became known as the “Volcker Shock.” While the jarring move resulted in the 1981 recession, it also led to the stable and low inflation rates of the next decades. Many shy away from this strategy, however — including Federal Reserve Governor Christopher Waller, who told CNBC in April, “I don’t see value in trying to shock the markets; we are not in a Volcker kind of moment.”
5. Between the end of World War II and the current inflation surge, there were six periods when U.S. inflation exceeded five percent.
The Consumer Price Index exceeded five percent per year for a year and a half starting in 1946, for all of 1951, for a two-year period starting in 1969, and then for nearly a full decade starting in April 1973. This last period of extended inflation was broken by the “Volcker Shock” — and Volcker’s method of aggressive Fed intervention to stave off inflation kept the rate below five percent for most of the next four decades. The exceptions were the late 1980’s recession, and one month in summer 2008 at the beginning of the Great Recession.
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