Economic Professors Say Fed Rate Hike Should Slow Inflation

The Federal Reserve announced the rate hike on March 16. The measure is the first in a series of hikes that the Fed has planned to address inflation.

In theory, the Fed's plan should work, said Russell Lay, who teaches economics at College of The Albemarle.

"The question is whether it is enough of an increase to slow inflation and how many rate increases will we require to accomplish that goal."

Typically, the Federal Reserve targets 2% as the nation's inflation rate, which has crept up nearly 6% since early early last year.

"That is worrisome," said Kingsley Nwala, a business and economics professor at Elizabeth City State University.

According to Nwala, the national inflation rate for January was 7.45% and February's rose to 7.9%. The March figures will be available in April.

Officially known as the federal funds rate, the Federal Reserve rate is the interest rate banks pay to borrow and lend to one another.

The March 16 increase hiked the rate from near 0 percentage points from before the pandemic to .25%, setting the rate somewhere between .25% and .5%. The central bank also plans six additional rate increases to bring the overall rate to 1.9% by the end of this year, with three more increases likely in 2023, Nwala said.

Inflation is when consumers' buying power is weakened by the rising costs of nearly all goods and services. In essence, the U.S. dollar today is not worth as much as it was a year ago.

"Inflation erodes your buying power," Nwala said.

One way to address rising inflation is to slow consumer spending by increasing the Fed interest rate, he said. The aim of increasing the federal funds rate is to raise the cost of consumer credit, Lay said.

"Inflation occurs when too many dollars are chasing too few goods," he said. "Banks routinely borrow from one another overnight to meet regulatory requirements for liquidity. Since the pandemic that rate has been zero.

"Thus, any increase in the overnight rate for banks should result in an increase in loan interest rates and slow the economy down," Lay continued. "Also, other indexes used to price loan interest rates, such as the prime rate, key off the Fed funds rate, so loan rates based upon those indexes will also rise."

That means it could be more expensive for residents to borrow money to buy new cars or to finance a 30-year home mortgage.

Nwala said homeowners who have adjustable rate mortgages, as opposed to fixed rate mortgages, will be more affected by the Fed's rate increase.

Lay said residents may not feel the effects of a quarter-percent increase. That's because housing prices and the costs of household items are growing faster than the cost of credit, he said.

But on larger projects, even small rate increases can translate to large sums of money," Lay said. "If the rates jump by 1% or more this year in total, then monthly payments could rise enough to cause some people to fail to qualify for a mortgage or auto loan, or decide for themselves that the payment is now too much.

"Small business owners will also face the same issues if the rate increases continue alongside an upward increase in inflation for the goods and services they turn into products."

Nwala explained that two two fundamentals of economics — supply and demand — coupled with global supply chain shortages, are in part to blame for inflation.

At the onset of the pandemic, millions of workers lost their jobs, which equated to fewer people spending money, according to Nwala. This led to a drop in the consumer demand for goods, while supply was plentiful.

The national unemployment rate for February was 3.8%, a figure Nwala said equates to nearly a fully employed workforce. That is a significant rebound from the millions of jobs lost two years ago.

Along with unprecedented low unemployment comes an increase in consumer spending and demand.

"Now we are at 3.8% unemployment," Nwala said.

Low unemployment also means the labor force has the advantage now over companies seeking new workers, according Nwala.

"To find somebody to work for you is very competitive," he said. "Companies are shelling out money to attract workers."

Nwala also noted that throughout the pandemic, the federal government infused millions of dollars into the economy in the form of stimulus checks, money to help employers keep workers on their payrolls, grants and other means to keep the economy afloat.

Another factor in the Federal Reserve's decision to increase the key interest rate is the war in Ukraine, according to Nwala. "The Russian invasion doesn't make it any better," he said.

The Federal Reserve's announcement March 16 takes into account the war in Ukraine.

"The invasion of Ukraine by Russia is causing tremendous human and economic hardship," a news release states. "The implications for the U.S. economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity."

Lay said inflation was a problem in the United States long before Russia invaded Ukraine. He cautioned, however, that the war will challenge existing supply-chain shortages in many commodities, including oil and wheat. Higher costs for businesses will translate to higher prices for consumers, he said.

"This is why the Fed has stated future increases may be more than the .25% steps they were planning to take this year," Lay said. "So, the war will make an already troubled world economy even more unpredictable and likely, inflation prone."