About a month or two, the option of cutting interest rates became a very viable option. As inflation was declining steadily for more than 12 months, and the economy kept producing positive GDP growth, the possibility of a recession was actually averted. Many prominent banks such as Goldman Sachs, JP Morgan Chase, and Citigroup started predicting that the Federal Reserve would start cutting interest rates early next year. While Jerome Powell himself did not make such a declaration publicly, he and the Board of Governors unavoidably considered that option.
August Inflation Data
Source: U.S. Bureau of Labor Statistics
However, inflation started to increase again in July, and this increase continued for the second consecutive time in August. The inflation rate in the United States in July 2023 was 3.2%. This is based on the Consumer Price Index (CPI), which measures the change in prices of a basket of goods and services purchased by urban consumers. The July inflation rate was the same as the June inflation rate, and it was slightly below the peak of 9.1% in June 2022. In August, inflation rate increased to 3.7% from 3.2% in July.
The main contributors to the August inflation rate were gasoline prices, which rose 6.1%, and food prices, which rose 0.4%. Other major contributors were shelter, up 0.3%, and transportation, up 0.2%. Core inflation, which excludes food and energy prices, was 4.3% in August, down from 4.7% in July. This suggests that inflation is starting to moderate, but it is still well above the Federal Reserve's target of 2%.
It is now very unlikely that the Federal Reserve will consider cutting interest rates anymore. The recent surge in inflation rate keeps the central bank alarmed. The economy remains in a sensitive place and the Fed believes that cutting interest rates could lead to more inflation. When interest rates are low, people are more likely to borrow money and spend it, which can drive up prices.
The Federal Reserve’s goal remains the same: to reduce demand as much as possible to equilibrate it with supply. Consumer spending has been strong in recent months, despite rising inflation. In the second quarter of 2023, consumer spending grew at an annual rate of 3.3%. This was the fastest pace of growth since the fourth quarter of 2021. And the way for the Fed to reduce demand is to reduce consumer spending by maintaining interest rates high to make the cost of borrowing more expensive, by selling government bonds to reduce liquidity in financial markets, and by tightening reserve requirements. These methods are supposed to increase unemployment, which in turn, will affect people’s ability to spend.
Now that inflation has been increasing again, the Federal Reserve is now expected to continue raising interest rates in the next meetings to combat inflation and reduce demand. However, there is a limit to how much the Fed could increase interest rates. If the Fed continues to keep increasing interest rates, it could trigger a recession, which is also a situation that they are trying to avoid.
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