On Wednesday, September 21st, Federal Reserve Chairman Jerome Powell announced yet another interest rate hike to fight ongoing inflation. This is the third-consecutive rate hike of the year, and has raised rates to the 3-3.25% range with officials predicting that rates will rise to at least 4.25% by the end of the year.
The above graph depicts the change in the effective federal funds rate since the beginning of this year, demonstrating the aggressive nature of the Fed’s policy, especially with the steep rise beginning in April of this year. Last month, we examined factors of inflation that the interest rate hikes may not effectively target, particularly supply-side factors. Now, we will take a deeper look at what the interest rate hikes have actually impacted, and what implications that has for the economy.
The above graph shows two projections from the Federal Open Market Committee (FOMC): the blue series is the projection for the median federal funds rate while the red series is the projection for the growth of real gross domestic product. The FOMC predicts that around 2024, the growth rate of real GDP will slow down as a result of the current high interest rates, thus allowing for a reduction in the federal funds rate starting in 2023. This economic cooldown may be beneficial in taming inflation within the next 18 months, and does show a promising outlook for the near future in regards to high prices.
Another key impact of the rate hikes has been on the housing market. While fixed-rate mortgages remain unaffected, those with variable-rate mortgages or new mortgages will see increases in monthly payments. Interest rates do not directly affect mortgage rates; however, high inflation has eroded returns on investments into mortgage-backed securities (MBS). Consequently, lenders have had to raise rates to make the investment more attractive for the investors who buy these MBSs. A lack of confidence in the Fed to control inflation, stemming from the third consecutive rate hike without a tangible impact, has led to a rise in mortgage rates. This is seen empirically, with a 2% slowdown in the rate of increase of house prices. The implication here is that the housing market, which sparked fears of a bubble earlier on in the year, has clearly seen a slowdown in price increases as an indirect effect of the Fed’s rate hikes.
The Federal Reserve claims to be committed to a 2% inflation rate, and has stated that they will continue to be aggressive in their push to reduce inflation by a significant margin. With more rate hikes to come in the future, the impact on inflation and the economy as a whole will soon be realized.