The Federal Reserve lifted its key interest rate by a quarter of a percentage point on Wednesday as policymakers took their first decisive step toward trying to tame rapid inflation by cooling the economy.
The Fed had kept rates near zero since March 2020, and the decision marked its first increase since 2018. Policymakers also projected six more similarly sized increases over the course of 2022 as inflation comes in at a 40-year high.
“With appropriate firming in the stance of monetary policy, the committee expects inflation to return to its 2 percent objective and the labor market to remain strong,” the Fed said in its March statement, noting that the committee “anticipates that ongoing increases in the target range will be appropriate.”
The Fed is at an inflection point after two years of trying to help the economy to recover from the damage inflicted by the global pandemic. While the coronavirus continues to disrupt commerce around the world, the US economy has staged a swift recovery. America’s job market has rebounded rapidly from steep pandemic job losses that had pushed unemployment to 14.7 percent, and businesses are now struggling to find workers.
A surge in consumer spending has helped to push the rate of inflation to levels not seen since the 1980s. Instead of echoing the anemic slog back from the 2007-09 recession — one that kept millions of applicants out of work and left inflation tepid despite years of rock-bottom rates — the pandemic bounce-back has been vigorous.
Judging by inflation, it may even have too much heat, which is why the Fed is trying to slow the economy to a more sustainable pace.
“The economy is very strong,” Jerome Powell, the Fed chair, said at a news conference following the announcement, calling recent growth “robust” and the outlook “solid,” while saying that the labor market is “extremely tight.”
“Wages are rising at their fastest pace in many years,” he said, noting that inflation is “well above” the Fed’s target and that supply chain disruptions have been larger and longer-lasting than expected. Higher energy prices are pushing up inflation even more, just as price pressures broaden.
Higher interest rates will trickle out through markets to make mortgages, car loans, and borrowing by businesses more expensive. That is expected to slow consumption and investment, reducing demand in the economy and — Fed officials hope — eventually weighing down surging prices.
Central bankers plotted a more aggressive plan for controlling inflation than in December, when they last released economic projections. Officials now expect to raise rates to 2.8 percent by the end of 2023, based on the median estimate, up from 1.6 percent in their prior projections. That is high enough that, by the Fed’s own estimates, it might amount to actually tapping the brakes on the economy — not just taking a foot off the gas pedal.
“They knew their policy didn’t match the economic backdrop, and this is catch-up,” said Priya Misra, head of global rates strategy at TD Securities. “They’re giving a tough message that they expect they will have to slow growth to bring inflation under control.”
With the help of their policy changes, central bankers still expect inflation to begin to slow on its own this year, but they have become concerned that a meaningful deceleration will take time.
The Fed’s quarterly economic projections, released alongside the rate decision, showed that officials expected inflation to hover around 4.3 percent at the end of 2022. While that is less than 6.1 percent increase in the 12 months through January, it is well above the Fed’s goal of 2 percent.
James Bullard, president of the Federal Reserve Bank of St. Louis, voted against the committee’s decision because he favored a larger interest rate increase of half a percentage point.
The Fed directly addressed the possible economic implications of Russia’s invasion of Ukraine in its statement.
“The invasion of Ukraine by Russia is causing tremendous human and economic hardship,” Fed officials said in their statement. “The implications for the U.S. economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.”
Powell, speaking at the news conference, noted that the invasion of Ukraine and related events are a “downside risk.”
While the Fed is raising rates partly because inflation is so rapid, officials have also taken solace in labor market progress. Unemployment has dropped sharply, job openings are plentiful, and there are too few workers to go around.
The Fed aims for both price stability and maximum employment, and central bank officials have indicated that the labor market is meeting that latter goal, though they hope more workers will return as fears of catching the coronavirus ease and as child-care issues tied to school shutdowns and other virus mitigation measures fade.
A booming job market has helped to push wage growth higher because employers are competing for workers and trying to retain their existing employees by paying more. Higher compensation could fuel inflation down the road, some economists worry: It gives workers more wherewithal to spend, and it leaves firms trying to cover climbing labor costs.
The Fed is trying to avoid a situation in which both consumers and companies come to believe that prices will continue to increase briskly year after year. Expectations for higher inflation could prompt consumers to accept cost increases, could lead workers to ask for bigger raises, and could give businesses the confidence to continue lifting prices.
The question is just how far the central bank will have to go to make sure that price gains slow and inflation expectations remain under control.
Central bankers are hoping to engineer a soft landing: a situation where they can slow growth to a maintainable level without derailing the economy and causing a recession. Powell has been clear that he is willing to do whatever it takes to achieve price stability.
Asked Wednesday about that calibration, Powell said that, in his view, “the probability of a recession within the next year is not particularly elevated.” He cited strong demand, a healthy labor market, and other conditions that he said were signs that the economy will be able to flourish “in the face of less accommodative monetary policy.”