The Federal Reserve is driving the economy into a recession as it tries to fight inflation.
The Federal Reserve raised its benchmark overnight interest rate by three-quarters of a percentage point in an effort to cool the most intense breakout of inflation since the 1980s. And, there are further increases’ in borrowing costs still ahead despite evidence of a slowing economy in an effort.
Inflation has been raging in the U.S. while economic growth measured by GDP is slowing. The U.S. Commerce Department recently reported a second straight quarter of negative economic growth.
Generally, a central bank tightens money by raising interest rates when the economy is healthy or over heated in order to head off inflation. By making money more expensive to borrow, the Fed’s rate moves work relatively quickly to temper demand. As buying a house or a car or expanding a business becomes pricier, people pull back from doing those things. With fewer consumers and companies competing for the available supply of goods and services, price gains are able to moderate.
Larry Summers, the former Treasury Secretary, argued that the Federal Reserve needed to take “strong action” to control inflation and that allowing inflation to gallop out of control would be the “bigger mistake” than causing a recession. Summers blames inflation on the spending boom of 2020/2021 that spurred excess demand.
Summers believes to tame inflation the Fed must crush demand. But, slowing the economy down could trigger a recession, leaving workers unemployed and families with lower incomes.
Fed officials themselves acknowledge that their tools are blunt, that they cannot fix broken supply chains and that it will be difficult to slow the economy enough without causing an economic downturn.
References:
- https://www.nytimes.com/2022/07/27/business/economy/interest-rate-inflation-impact.html
- https://www.reuters.com/markets/us/fed-unveil-another-big-rate-hike-signs-economic-slowdown-grow-2022-07-27/