The big day has arrived. After playing mind games with the economy, Jerome Powell and the Board of Governors of the Federal Reserve finally met and made their decisions on interest rates: Interest rates will be raised once again by 0.25 basis- points. Interest rates just increased from 4.75% to 5%. What does it mean for all of us? It means that the Federal Reserve prioritized taming inflation by continuing to use interest rates as a tool to bring inflation down at the expense of inflicting pain on the economy. In other words, the Feds want to “disinflate” the economy. Now, the main question is: Was it the right decision to increase inflation by a quarter-basis point?
Before even focusing on the basis-points, let us first answer a more fundamental question. Should have the Feds increased or paused interest rates? The direct answer is that the Feds should have increased interest rates because inflation remains a serious issue. The Federal Reserve has to clean up the mess it created. Pausing interest rates means that the Feds would apply quantitative easing, which means the Feds would have to buy more treasury bonds from the government and other large assets in exchange for stimulating the economy. Economic growth through quantitative easing means increasing the money supply, lowering interest rates, and expanding credit. This would simply lead to more inflation, which is the very problem we are all trying to solve. Quantitative easing is the very reason why we have inflation in the first place. It, therefore, makes sense to increase interest rates to prevent inflation from growing further.
Now, should the Feds have increased rates only by a quarter basis point or a half basis point? Increasing interest rates by 0.25-basis points will surely bring inflation down, but only by a quarter or maybe half a point. That means that Inflation is currently at 6%. With these 0.25-basis point hikes, inflation is expected to drop to 5.75% or 5.50% at most. While this is a step forward, it is not sufficient because the Feds will increase once again interest rates after today’s decision, which will bring interest rates to 5.25%. If the Feds increased interest rates by 0.50-basis points, what would have happened? This decision would have been extremely painful in the short-term but it would generate long-term positive outcomes. What are these outcomes? If rates were hiked by 0.50-basis points, the credit market would have been extremely tightened and layoffs would have perhaps doubled if not tripled. This is the short-term pain that we would have all been going through. But inflation would have dropped by a full point (from 6% to 5%) if not more (from 6% to 4.5%), which means that prices will be going down significantly, as a result of a restriction of liquidity, and wages would have been increasing. What is important to comprehend is that a 0.5 basis point hike would have been a one-time decision that would have amortized inflation for a long time. In other words, increasing rates by 0.5 basis points, would have been a “two birds one stone” kind of deal to seal. One thing we are sure of is that these rates hike of March 22, 2023, won’t be the last one, this will only prolong the pain that consumers have to endure for the time being.