Inflation falls but interest rate increase ‘only solution’

The Consumer Price Index (CPI) inflation rate for the 12 months to March 2023 dropped to five percent, according to official figures. This is a decline from six percent in February 2023 and is the slowest pace for price rises since 2021.

The Federal Reserve has raised interest rates in a bid to mitigate the damage caused by inflation on the economy.

While this has been beneficial for savers, those struggling in debt and with mortgage repayments have been detrimentally affected.

Through the Federal Open Markets Committee (FOMC), the federal funds rate is set to determine overnight lending among banks.

This rate has a range between an upper and lower limit and is currently set at 4.75 to five percent.

Despite yesterday’s news, experts are sounding the alarm that further interest rate hikes may be necessary.

This is because the Federal Reserve has a legal mandate to maintain price stability and one of the tools at its disposal to do this is raising rates.

Millions of households over the last two years have been forced to contend with a sharp increase in the prices of goods and services.

Finance analysts believe further stability is needed over a longer period of time for costs to come down significantly.

Jonathan Thompson, associate professor of Economics at Willamette University, shared why further intervention may be needed.

He explained: “Raising interest rates is more or less the only long-term solution. That being said, the optimal level of inflation and whether rates need to be raised even more than they already have been are open questions.

“The Federal Funds rate was basically zero one year ago and is now almost five percent, which pushes up the price of credit and pushes down asset prices at the margin, making future investments, existing investments, and marginal consumption all decline.

“Additionally, whether the optimal rate of inflation is two or three or five or even 10 percent is not really well known; most macroeconomists believe that consistency is more important than a specific level, that negative values are far more socially costly than low positive values and that some high level, even consistently, is probably worse than a lower level.”

For last month’s CPI rate, housing was the largest contributing factor to costs going up in recent months.

Housing prices rose by 0.4 percent over March, with an 8.2 percent increase over the year the last year.

However, this was offset by energy prices going down by 6.4 percent over the 12 months and food costs stabilising.

Despite signs of improvement, experts are highlighting that the current global issue of inflation will still have long-term consequences for years to come.

Prof. Brown added: “One, the financial sector will grow as people will spend more to protect their wealth from volatile shocks.

“Two, there will likely be asset and industry bubbles as the timing of price changes in inputs or outputs will create a temporary appearance of substantial profitability.

“Three, the labor market will experience more churn (higher quit rates for a given unemployment rate) as people seek out industries that are booming.

“There will likely be international turmoil as governments, especially those highly exposed to price volatility in specific commodities, face either revolution or default on existing debt.”

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