Today, the Federal Reserve (also known as the Fed or US Central Bank) decided to raise interest rate (by half of a percent). A big deal because it’s the the largest hike in two decades. And more is to come. The stated reason for the hike is to tame inflation.
Now, if you were like me, a question popped into my head: why did they push the rate higher when the inflation is already making everything more expensive? So I did some digging, and here is my take on it.
The Fed has pumped money to simulate the economy during the last two years of pandemic. The policy worked well. People were able to spend those extra money on car, food, house, or whatever. The US economy has done well during the pandemic.
Problem arose when our output is slowed due to the pandemic. Whether due to supply chain crisis or unemployment, the effect is our demand exceeded the supply. And the prices go up. Given the pandemic is not going away, the gap is prolonged and driving the inflation. This is where the Fed steps in.
By raising the interest rate, the Fed is hoping that you and I will borrow less and purchase fewer due to the higher cost of money. So to achieve the desired effect of cooling down the economy. The Fed will continue to raise the rate until the economy is not overheated. Meaning the inflation is under control at about 2 percent.
You may wonder what does QT has to do with the inflation? First, the QT stands for quantitative tightening. It is a technical term in monetary policy opposite to the Fed pumping money into the economy (also known as QE or quantitative easing). What goes up must come down.
What do you anticipate will take to tame the inflation?