Due to COVID-19 and the war in Ukraine, inflation in the United States has drastically increased. In response, the Federal Reserve Bank (the Fed) has continuously used interest rate hikes in an attempt to combat inflation. During the pandemic, the Fed brought the interest rate to 0% to stimulate the nation’s economy. However, throughout 2022 the Fed consistently raised the interest rate and ended the year at 4.5%, the highest level in 15 years. Raising interest rates helps decrease inflation by increasing the cost of borrowing money for both consumers and businesses. This interaction decreases the demand for goods and alleviates the upward pressure on prices (Paul 2022). 

To better analyze the effects of inflation on the United States economy we can use something as simple and as random as eggs. The price of eggs increased 59.9% in 2022. It may be impossible to tell whether the price of eggs increased due to supply chain issues or the global inflation conflict. Regardless, the price of eggs increased exponentially (CNBC 2023). This price increase will cause some households to holdout on buying eggs which will result in costly consequences on the egg business. While eggs are a specific example, giant price increases were routine during 2022. This showcases the need for the Fed to attack inflation head on. An interest rate hike typically takes 12 to 18 months to influence the economy (Levin 2022). According to Levin, with the first rate increase being implemented in March of 2022, its full effects will not be seen on the economy until September 2023. 

While interest rate increases are oftentimes used to reduce inflation, the delay of the effects is causing both inflation and interest rates to soar as of Q1 in 2023. When inflation is too high it is detrimental to the economy–it not only causes prices to rise, but also creates great amounts of uncertainty among the public. When interest rates are too high it is harmful to the economy because it decreases the demand for goods and slows economic growth (US Bank 2023). Furthermore, when both the interest rate and the inflation rate are high it creates financial uncertainty in the United States, mainly affecting moderate to lower income families and individuals. Overall, the economy in the United States is going to struggle while both of these factors remain high. 

Though it may take time, Ellen Chang, a freelance journalist who covers many articles concerning the economy, claims inflation should continue to decline gradually towards the United States 2% target in 2023 (Forbes 2023). Many economists are convinced the high-interest rate will eventually cause this decline. When interest rates are high, it reduces the amount of money that is being spent by both consumers and businesses, in turn reducing prices of goods and services, reducing inflation. However, economist Joseph E. Stiglitz argues that the 2022 inflationary problem was not caused by the high demand for goods, but rather a lack of supply of goods. The pandemic and the war in Ukraine caused an immense amount of supply chain issues. Stiglitz asserts that raising the interest rates to lower inflation was an erroneous decision. While high-interest rates solve the problem of inflation, it creates damaging consequences with the possibility of causing the United States to enter into a recession. As defined by the National Bureau of Economic Research (NBER) Business Cycle Dating Committee, the official tracker of recessions in the United States, a recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months”(NBER 2022). Stiglitz (2023) believes that as the supply chain issues are resolved, the economy itself will be remedied with time.

However, not all recessions are caused by high-interest rates. The most recent recession occurred during the pandemic. The pandemic effectively halted economic activity for an extended period of time. An example of a recession caused by high-interest rates is displayed through the 1981 recession The 1981 recession was a result of tight monetary policy. Inflation was extremely high in 1980. In response, the Fed steeply increased interest rates, an action that was ultimately detrimental to the economy. In 1980 the Fed increased rates to around 20%, an outrageously high percentage. This action resulted in the quick escalation of the unemployment rate because businesses needed to lay employees off due to less demand for their products. Prior to the 2007 recession, 1980 was the worst economic downturn since the great depression (Federal Reserve History 2013). The Fed has clearly learned something from this mistake, shown through the usage of small incremental rate hikes in 2022 instead of extreme rate hikes, like the one used in 1980, to manage the high inflation. 

The Fed may have still raised interest rates too high. The Fed began 2023 by increasing rates by another 0.25 basis points. This makes the current interest rate 4.75% as of February 2023. While this is the smallest increase since March of 2022, it remains concerning to see the rates still increasing. The Fed chooses to increase rates more because the inflation rate is still above the government-mandated level of 2%. There is a clear trend throughout American history that when rates spike, as they did in 2022, a recession follows. An article published by the Wall Street Journal in January stated that “more than two-thirds of the economists at 23 large financial institutions that do business directly with the Federal Reserve are betting the U.S. will have a recession in 2023. Two others are predicting a recession in 2024” (Rabouin 2023). The reason economists are so confidently predicting a recession is because of the trend mentioned above. The Fed is aware of this pattern, but they’re in a difficult position where they have to make sacrifices to fulfill their duties demanded of them by the government's dual mandate to keep both inflation and unemployment low and stable.

A recession causes the unemployment rate to increase causing millions of Americans to lose their jobs. The Phillips curve can illustrate this scenario. This economic concept states that inflation and unemployment have an inverse relationship. As proven by history, when inflation is low it results in a high unemployment rate. As inflation decreases the unemployment rate is going to increase. Millions of Americans losing their jobs is not only terrible from a humanistic standpoint, but also from an economic point of view because unemployment adversely affects the economy. An increasing unemployment rate reduces the total output of the country by decreasing disposable income of families. 

The Fed raised interest rates in an attempt to bring inflation down. In their attempt to do so, the Fed has affected the economy in a negative way. The price of eggs decreased 52% from its peak in December to January (CNBC 2023). The decrease in price may be due to the interest rates working, or they could be due to the supply chain issues being resolved. In either case, it doesn’t change how the high interest rates will affect the United States. By analyzing past trends and current patterns, economists are fairly confident that the United States is going to enter its second economic downturn in three years. One can only hope that a recession will be avoided or at least minimized to avoid the detrimental consequences individuals would face worldwide.

References

NBER. 2022. “Business Cycle Dating Procedure: Frequently Asked Questions.” 15 Aug.  https://www.nber.org/research/business-cycle-dating/business-cycle-dating-procedure-frequently-asked-questions. 

Chang, Ellen. 2023. “When Will Inflation Go down?” Forbes, Forbes Magazine, 13 Jan. https://www.forbes.com/advisor/personal-finance/when-will-inflation-go-down/. 

Duggan, Wayne. 2023. “February Fed Meeting: FOMC Delivers Smaller, Gentler Rate Hike.” Forbes, Forbes Magazine, 1 Feb. https://www.forbes.com/advisor/investing/another-50-point-fed-rate-increase/#:~:text=This%20key%20interest%20rate%20impacts,financial%20institutions%20to%20borrow%20money. 

The Fed 2023.“Federal Open Market Committee.” Federal Open Market Committee 1 Feb. https://www.federalreserve.gov/monetarypolicy/fomc.htm. 

U.S. Bank. 2022. “How Do Rising Interest Rates Affect the Stock Market?” 16 Feb. https://www.usbank.com/investing/financial-perspectives/market-news/how-do-rising-interest-rates-affect-the-stock-market.html#:~:text=Higher%20rates%20alter%20the%20equity%20investment%20landscape&text=for%20U.S.%20companies.-,“As%20the%20Fed%20tightens%20interest%20rates%2C%20we%20can%20expect%20a,0.6%25%20in%20the%20second%20quarter. 

Iacurci, Greg. 2023. “School Lunch, Eggs and Airfare: Why Inflation Soared for 10 Items in 2022.” CNBC, 13 Jan. https://www.cnbc.com/2023/01/13/why-inflation-hit-these-10-items-hardest-in-2022.html. 

Iacurci, Greg. 2023. “Wholesale Egg Prices Have 'Collapsed.' Why Consumers May Soon See Relief.” CNBC, 8 Feb. https://www.cnbc.com/2023/02/07/wholesale-egg-prices-have-collapsed-from-record-highs-in-december.html. 

Levin, Matt. 2022. “How Long Does It Take for Fed Rate Hikes to Work?” Marketplace, 28 Oct. https://www.marketplace.org/2022/10/28/how-long-does-it-take-for-fed-rate-hikes-to-work/. 

Mericle, David, and Alec Phillips. 2023.“Why the US Can Avoid a Recession in 2023.” Goldman Sachs, 5 Jan. https://www.goldmansachs.com/insights/pages/why-the-us-can-avoid-recession-in-2023.html. 

Rabouin, Dion. 2023. “Big Banks Predict Recession, Fed Pivot in 2023.” The Wall Street Journal, Dow Jones & Company, 17 Jan. https://www.wsj.com/articles/big-banks-predict-recession-fed-pivot-in-2023-11672618563. 

Sablik, Tim. 2013. “Recession of 1981–82.” Federal Reserve History, 22 Nov. https://www.federalreservehistory.org/essays/recession-of-1981-82. 

Stiglitz, Joseph E., et al. 2023. “How Not to Fight Inflation: By Joseph E. Stiglitz.” Project Syndicate, 31 Jan. https://www.project-syndicate.org/commentary/us-inflation-fed-interest-rates-high-costs-dubious-benefits-by-joseph-e-stiglitz-2023-01?utm_source=Project%2BSyndicate%2BNewsletter&utm_campaign=4664fcdbe0-sunday_newsletter_01_29_2023&utm_medium=email&utm_term=0_73bad5b7d8-4664fcdbe0-107281873&mc_cid=4664fcdbe0&mc_eid=c91e639e16. 

CBCnews. 2022. “U.S. Federal Reserve Raises Interest Rates by Half a Point | CBC News.” CBC/Radio Canada, 14 Dec. https://www.cbc.ca/news/business/us-federal-reserve-interest-rates-1.6685534.