As inflation grips Texas and the country with 40-years highs, the country’s central bank is taking action to bring prices down. The Federal Reserve has been raising interest rates by the largest increases since 1994 to reduce inflation.
With still-rising inflation numbers up 9.4% in the DFW area and across the nation at 8.5% in July, the Federal Reserve is expected to continue raising interest rates.WalletHub ranked the DFW metropolitan area 12th for where inflation is growing the most.
The Fort Worth Report spoke with three Texas economists to explain how Federal Reserve hikes work.
The Federal Reserve, or Fed, is the country’s central bank. It manages the nation’s money supply, sets monetary policy and regulates the financial system. There are twelve Federal Reserve banks and 24 branches spread across the country. The banks gather economic data and information about businesses in the region, which is considered when monetary policy is made, according to the Federal Reserve website.
Congress assigned the Fed two overall economic goals: Keep prices under control and unemployment low. Sriram Villupuram, associate professor of finance and real estate at the University of Texas at Arlington, said the Fed wants to keep the consumer price index, a measurement for inflation, as low as possible, close to 2%.
What is inflation?
Imagine the price of bread is selling for $5 at a local grocery store. Then, a year later, that same loaf sells for $7. That’s an example of inflation.
The International Monetary Fund defines inflation as the measurement of how prices for goods or services have increased over a period of time. The Bureau of Labor Statistics measures inflation through the Consumer Price Index, which measures prices each month over a 12-month period, coming up with a percentage of inflation for the country and for each region.
“If it’s zero or negative, then people start to think, ‘Hey, prices are falling. Let me wait to buy this good tomorrow, next week, next month,’” Villupuram said. “If everybody postpones and no one’s buying anything, then it becomes a self-fulfilling prophecy. Too much delay in buying things, that could crash the market.”
The central bank tries to reduce inflation by raising the Federal Fund Rate, which is the rate that banks are charged for borrowing money overnight. Because it costs more for the banks to borrow, banks tend to charge higher interest rates, too, Clare Losey, a researcher at Texas A&M’s Real Estate Research Center, said.
That tends to make monthly mortgages more expensive, Losey said. Home buyers needed to make about $10,000 more as mortgage interest rates jumped, according to past Fort Worth Report coverage.
“As that total monthly mortgage payment increases, it means that the borrower actually needs to make a higher income in order to qualify for the same price,” Losey said.
Raising rates can also make it more expensive to get a car loan, buy a car or keep a balance on a credit card, Pia Orrenius, senior economist at the Federal Reserve Bank of Dallas. It could dissuade businesses from borrowing too. Many businesses borrow for pursuits like opening stores and investing in technology, she said.
Inflation is important to regulate because, if it runs too long, it can cause “inflation expectation,” Orrenius said.
“Firms and individuals, consumers, businesses, they begin to bake in a presumption of a price increase every month or every quarter or every year and then you can get systemic inflation, which then becomes almost impossible to get rid of,” Orrenius said.
Long-term inflation can impoverish the nation, especially those who already live with limited resources, which is one reason why the central bank tries to control it, she said.
There’s some risk that comes with raising interest rates. Pressing the brakes too hard on the economy can cause a recession.
The Federal Reserve is aiming for what it calls a “soft landing,” Orrenius said, which means cooling inflation without causing a recession.
“In a soft landing, you’re not going to see large increases in the unemployment rate,” Orrenius said. “You’re not going to see huge layoffs, you’re not going to see declining wages.”
Historically, the Federal Reserve has struggled to achieve a soft landing. An example is the 1980s, when the central bank raised interest rates to about 20% and triggered a recession.
However, economists like Villupuram said after that recession, inflation was under control and the economy entered one of the country’s longest bull markets.
“Every asset type increased in value, real estate went up in value, stocks went up in value,” Villupuram said. “That was the longest ever great market period for the United States from the mid ’80s to about 2005 or 2006.”
The Federal Open Market Committee, a committee made up of federal reserve bank presidents and board members, meets to determine whether it will raise rates. The next meeting is in September.
“The year-on-year inflation is still very, very far away from our target, which is 2%,” Orrenius said. “So my guess is, there will be more action to come.”
Seth Bodine is a business and economic development reporter for the Fort Worth Report. Contact him at email@example.com and follow on Twitter at @sbodine120.