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Not so fast on interest rates

The Federal Reserve must take a more gradual and patient approach to addressing inflation.

A shopper holds a shopping basket with groceries inside a grocery store in San Francisco on May 2.David Paul Morris/Bloomberg

Americans have an inflation problem, and it’s not going away anytime soon.

That was made clear in the latest round of data from the Labor Department, which showed a slight uptick in consumer prices in August. The numbers came as a surprise given the steady decline in gas prices, and they contradicted economists’ expectations of moderately good inflation news. While overall prices rose 8.3 percent compared to August of last year — down from a peak of 9.1 percent — they also increased by 0.1 percent from the previous month, raising concerns about how persistent and entrenched inflation has become.


As a result, the Federal Reserve is largely expected to announce another aggressive interest rate hike on Wednesday in its ongoing effort to tame inflation. The Fed’s chair, Jerome Powell, said as much before the Labor Department’s report came out. “It is very much our view, and my view, that we need to act now forthrightly, strongly, as we have been doing,” he said earlier this month. “We need to keep at it until the job is done.”

It’s hard to see how the new inflation data will change Powell’s mind. Indeed, an uptick in prices shows that the Fed ought to be raising interest rates to slow the economy down. The question is how much and for how long? And when it comes to the Fed’s principal lever — that is, setting short-term interest rates — there is still reason for Powell to proceed with caution.

The next interest rate hike is anticipated to be the third consecutive 0.75 percentage point increase by the Fed. Some economists suggest that rates might actually be raised even higher — by a full percentage point — which would be the largest hike in over 40 years. But while a spike is essentially a foregone conclusion at this stage, the Fed should take a break from its overly aggressive approach going forward. Otherwise, it risks imposing a recession that quickly goes out of control, making an already bad situation worse.


A lot is still unknown about the state of the economy and inflationary trends, which is why the Fed must be patient. While the latest round of data was certainly alarming — inflation, for example, seems to be persistent in areas where supply chain issues have significantly improved — there is reason to believe the situation might not be as bad as it looks. A day after the Labor Department released its data on consumer prices, it showed that the Producer Price Index, or wholesale prices, declined as expected. That shows that inflation is in fact slowing, but it may take a little bit of time to see that reflected in the prices consumers pay.

There are also other indicators that overall consumer prices are lagging behind current trends. Shelter, for example, makes up nearly a third of the Consumer Price Index, and rising rents account for a large part of the uptick in prices in August. Market research has shown that rent increases are starting to decelerate and that national vacancies are starting to increase. As a result, it’s reasonable to expect rents to decline in the coming months. But, as the Fed surely knows, it takes a while for that to show up in the government’s data since it measures existing rents — which are typically pegged to annual leases — as opposed to what current openings are listed for in today’s market.


The problem with aggressively raising interest rates is that not only is there a lag in the government’s consumer price data, but it also takes a long time to see the overall impact of higher interest rates materialize. According to a recent study done by economists at the Fed, a rise in interest rates can cause unemployment to quickly jump before the government is even able to notice.

“Strong (tight) labor markets can become weak (slack) faster than policymakers may anticipate,” the report, which was published in July, argues. “Indeed, our results demonstrate that labor demand reacted sharply and quickly to the tightening of monetary policy, at a speed which can outpace policymakers’ abilities to track current economic conditions.”

A spike in unemployment may well be what Powell is looking to achieve. As he said in a speech last month, “While higher interest rates … will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation.” That pain is having many people, potentially millions, lose their jobs. And the bigger problem is that Powell could quickly lose control over unemployment levels, risking yet another deep recession in this still young century.

The truth is that the Fed’s interest rate hikes don’t have a direct impact on most factors driving inflation today. They don’t bring down the price of food, rent, or health care. And they certainly don’t fix the remaining and unpredictable supply chain disruptions in the current global economy. So if the Fed successfully reduces aggregate demand by imposing pain on households across the country — in the hopes that less spending will lead to lower prices — that could backfire and result in Americans facing a double whammy for some time: high inflation and high unemployment. That’s precisely the kind of pain the Fed is tasked with preventing, and Powell should not be so cavalier about potentially making that outcome a reality.


Editorials represent the views of the Boston Globe Editorial Board. Follow us on Twitter at @GlobeOpinion.