Gas prices are displayed at a gas station on February 8, 2022 in Los Angeles, California.
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Those tired of paying higher prices for most things shouldn’t expect help anytime soon from the Federal Reserve.
Although the central bank is about to embark on an anti-inflation strategy, its impact will not be felt for months or longer, economists say.
That’s because the Fed can’t order a price cut. All it can do is tighten the money supply and trust that everything will go well from there. The central bank does that through raising interest rates, which are expected to begin in March and – eventually – reduce the cost of living.
“What it will do is it will limit the duration of the price increase,” said Joseph Brusuelas, chief economist at RSM, an accounting service. “The expectation that we should all have is that the action the Fed takes today really won’t be clear until the fourth quarter of this year and also next year.”
The Fed’s predictions for action come as the latest consumer price index, which measures the cost of dozens of everyday goods and services, up 7.5% in the past year in January. That was the fastest growth since 1982, when the economy was dealing with stagnant inflation and a double recession.
Prices increased across the board. In December alone, cereals increased by 1.8%, ham by 2.5% and the price of fresh fish by 2.4%. That is due to the continued increase in food, energy and housing.
In an attempt to resolve the issue, markets expect the Fed at its March meeting to raise its benchmark borrowing rate by at least 0.25 percentage points, and maybe double. Wall Street thinks the Fed will raise rates at least five more times after that before the end of 2022.
But monetary policy works with lag, meaning it takes time for exchange rate moves to circulate in the economy. Economists believe there are six months to a year left before those efforts actually take effect.
“There is nothing the Federal Reserve can do about the current increase in inflation in the near term,” Brusuelas said.
However, over the long term, raising interest rates has proven to be an effective way to curb inflation.
‘A question of time’
The way it works is that higher rates make it less able to borrow money, thus slowing down credit. At the same time, a higher cost of money pours into the dollar, enhancing the value of the U.S. currency and providing consumers with more purchasing power.
If that sounds a bit annoying, there’s a reason for it. The Fed has no way of directly reducing the price of a grocery store loaf or a fast-food burger or even a gallon of gas, which has been 40% more expensive in the past 12 months.
There’s another problem: This isn’t your garden-like inflation cycle, but it’s generally caused by skyrocketing credit. Instead, much of the current situation has come thanks to unprecedented cash direct flow from the federal government through pandemic-related payments to households and indirectly from the Fed and the amount of money it pumped into the economy through lending and liquidity programs, along with near-zero short-term interest rates.
“We are in an asset cycle, not a credit cycle,” said Steven Blitz, chief US economist at TS Lombard. “The inflation we’re seeing is a function of the one-time equity infusion into households and small business balance sheets. The money was spent and it was spent at the time. limited ability to supply that demand.”
Indeed, until recently Fed officials used the word “temporary” to describe inflation that occurs through pandemic-related factors such as increased demand for goods relative to services and constraints on supply chains caused by the spread of Covid.
But the price hike has proven to be stronger and more durable than policymakers anticipated.
After months of erasing inflation as a bygone stage, Fed officials must now take delayed actions that will affect the economy but through indirect channels.
“The only way the Fed can slow this down is through a stronger dollar that lowers the cost of imports,” Blitz said. “It not only lowers the cost of imports, but it also increases the cost of producing goods elsewhere outside the United States and reduces the need for labor.”
The conundrum for the Fed will be to make sure the cure isn’t worse than the disease, that its anti-inflation rate cuts. Don’t make the economy spin and hurt those at the lower end of the income spectrum that aggressive spending policies are meant to help.
“Can the Fed reduce inflation? Yes, it can,” Blitz said. “But the question is what happens next? It’s a question of timing.”
