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How Does the Fed’s Interest Rate Hike Affect the Economy?

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The Federal Reserve (Fed) decided to raise interest rates again to 0.75 %, emulating the June hike, which at the time was the largest increase in the central bank’s interest rates since 1994. At that time, inflation in America was 2.7 % per year, at present it reached 9.1 % per year during the month of June.

With the interest rate spike, the federal funds’ reference rate is now between 2.25 %—2.5 %. The decision was unanimously supported by the twelve members of the Federal Open Market Committee (FOMC), according to the press release issued after the meeting.

For some analysts, inflation has already peaked and will begin to moderate in the coming months, starting with energy and food prices, which have been the main drivers of price increases in recent months.

Powell left open the option of continuing to raise interest rates during the next FOMC meeting. The Fed itself expects to continue raising interest rates until mid-2023. According to the Fed’s implementation notes, central bank governors may be considering raising the benchmark federal funds rate to 3.5% by 2023, a figure not seen since January 2008, months before the start of the sub-prime crisis in America.

How does the interest rate hike affect ordinary Americans?

The rise in interest rates signals a rise in the cost of debt for Americans. Credit cards, student loans, new mortgages, and other types of loans tend to get more expensive with each new interest rate hike by the central bank that lends to commercial banks that lend to consumers.

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Another immediate consequence of the Fed’s interest rate hike is that many Americans with bad or poor credit history immediately become automatically ineligible for a loan, as banks raise their credit score requirements to approve any loan.

According to a recent survey by travel agency Upgraded Points, one in five people are afraid to read their credit card statements, in fact, credit card balances jumped to a record $77 billion during the first quarter of June and accumulated total liabilities of $841 billion, according to data from the New York Fed.

Jerome Powell contradicted the White House narrative that denies the likelihood of a recession.

“Over the next few months, we will be looking for convincing evidence that inflation is coming down, namely inflation returning to 2%,” said Jerome Powell, Fed chairman, who during 2021 maintained that the central bank was sticking to its long-term goal of keeping inflation around 2% and maintained that it was transitory.

“This process is likely to end in a period of below-trend economic growth and some weakening in labor market conditions, but such outcomes are likely to be necessary to restore price stability and set the stage for maximum employment,” Powell said at the press conference after the Federal Open Market Committee (FOMC) communicated its decision to raise interest rates.

With this speech, Powell contradicts the narrative of the Biden administration, which has fallen into a state of denial over the possibility that the U.S. could enter a recession before the midterm elections. In desperation, the White House has come out to tell Americans to look at inflation with a holistic view and ignore headlines that claim two consecutive periods of negative growth means a recession.

The decision to raise interest rates comes in an international context in which the Chinese economy is facing a financial crisis generated by the Chinese government’s attempts to prevent the collapse of the country’s real estate market. On the other hand, although energy prices are decreasing, a potential cut in the supply of gas or oil by Russia to the European Union could trigger energy prices again.

The stock markets have maintained an optimistic behavior, mainly driven by the share prices of the so-called FAANGs —Facebook, Amazon, Apple, Netflix, and Google— which have seen moderate recoveries in their prices, after a semester in which they were mainly bearish.

At a recent conference of central bankers, Jerome Powell said that “the process is highly likely to involve some pain, but the worse pain would be in failing to address this high inflation and allowing it to become persistent.” However, his colleague, European Central Bank President Christine Lagarde, contradicted him by stating that “I don’t think that we are going to go back to that environment of low inflation.”

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