The Federal Reserve continues to raise interest rates in its fight to end historic inflation.
The central bank has increased borrowing costs and slowed the economy in an effort to reduce demand for goods and services, which leads to lower prices.
But several other factors weighing on prices, such as geopolitical conflicts and natural disasters, are beyond the Fed’s control. And the Fed can only go so far with interest rate hikes without cooling the economy too much and causing a recession.
Rate hikes have an impact
The Fed hiked rates by 25 basis points on Wednesday, the smallest increase since March 2022. Fed officials say that while the rate hikes are slowing inflation, more hikes are likely on the way.
Prices rose 5% annually in December, down from 5.5% in November and 6.1% in October, according to the Personal Consumption Expenditure (PCE) Price Index, the preferred inflation gauge from the Fed.
“We’re not done at all. But inflation cooled, and faster than me and others who were so shocked when the Fed acted late,” said Karen Petrou, managing partner at policy research firm Federal Financial Analytics.
Other data points indicate that rate hikes are having the expected effect of reducing demand and slowing the economy.
Consumer spending has declined for two consecutive months. Oil prices are hovering around their lowest level in a year. Ocean freight rates, which have skyrocketed in recent years, have returned to end-2020 prices.
Wages and employee benefits, another key indicator closely watched by the Fed, grew just 1% in the fourth quarter of 2022, the smallest increase in a year.
Demand in the housing market has slowed as higher mortgage rates make buying a home more difficult.
Existing home sales have declined for eleven consecutive months, according to the National Association of Realtors. Home price growth has slowed dramatically from extreme gains in recent years and has turned negative in parts of the US
The story continues
“Mortgages are where the Fed has the heaviest foot in terms of braking sharply and having minimal time lag between what it does and how a market cools,” Petrou said.
However, economists note that the Fed can only go so far without plunging the US into a recession. Higher interest rates could lead to 1.6 million job losses by the end of the year if the Fed’s projected hike in the unemployment rate comes true, while other economists are predicting higher unemployment figures.
“Pushing millions out of work is not the answer to tackling inflation. Further rate hikes could jeopardize our strong job market and low-wage workers and black and brown workers would suffer the greatest economic consequences,” Rakeen Mabud, chief economist at the Progressive Groundwork Collaborative, said in a statement.
Other factors beyond the Fed’s control
While headline inflation is easing, food prices remain stubbornly high – up 0.3% in December and 10.4% year over year, according to the Department of the United States’ Consumer Price Index (CPI). work – and there’s not much the Fed can do about it.
The price of a dozen eggs, for example, skyrocketed from $1.79 to $4.25 from 2021 to 2022, according to Department of Labor data. This is largely caused by an avian flu epidemic which led to the death of 58 million laying hens.
Russia’s invasion of Ukraine, a major grain supplier, drove up grain and vegetable oil prices last year. Although prices have come down, they still remain above pre-pandemic levels. The war also raised the price of fertilizer, a major Russian export, costs that were passed on to consumers in the supermarket.
Barbara Smith, 71, a volunteer at a Tampa Bay food bank, said sky-high prices forced her to buy less at the grocery store and take some food home from the pantry.
“You don’t buy groceries like you normally do. You just get what you need, and that’s it,” Smith said.
Extreme drought in the US has pushed up the price of vegetables and nuts, while bad weather in Brazil has caused the price of coffee to rise 14.3% over the past year.
“These are all markets with huge externalities. The Fed really has no control over the weather or the amount of grain flowing out of Ukraine,” Petrou said.
Part of the Fed’s goal is to slow wage growth to reduce demand for products and services. Federal Reserve Chairman Jerome Powell estimates that the US labor force is fewer than 3.5 million people, which increases the influence of workers on their wages and increases costs for businesses.
But even Powell acknowledges that the Fed can’t do much about the roughly 2 million early retirements that have occurred during the pandemic. The excess deaths and lower immigration caused by COVID-19 have also weighed on the labor market.
Other global events have the potential to impact prices, such as China moving rapidly towards the end of years of COVID-19 restrictions and reopening its economy.
Demand for oil could soar to record highs this year, with pent-up demand in China accounting for most of the increase, according to a recent report from the International Energy Agency.
The Fed can’t stop corporate markups
While costs are rising for businesses, corporate profits have soared to record highs, indicating that some price hikes are outweighing the additional costs.
A January study by Kansas City Fed economists found that corporate price markups accounted for more than half of inflation in 2021.
Federal Reserve Vice Chairman Lael Brainard, one of the more liberal economists on the board, highlighted corporate profit margins in recent remarks, noting that “final prices have risen more than increases in input prices.”
Companies, especially those in highly established industries, have been able to raise prices as strong demand has outstripped supply for goods and services.
Consumer distress has translated into unprecedented profits in a number of industries. ExxonMobil on Tuesday reported a profit of $56 billion for 2022, breaking oil industry records.
Lawmakers have accused some companies of using supply shortages and inflation to raise prices to unreasonable levels.
Senator Jack Reed (DR.I.) recently asked the Federal Trade Commission (FTC) to investigate allegations of price fraud and collusion by egg producers.
This came after progressive farming group Farm Action called out dominant egg producer Cal-Maine Foods for raising prices and increasing its year-on-year profits by 600% despite not reporting any cases of the flu flu.
“In a truly competitive market, one would have expected rival egg producers to respond to a nearly tripling of average prices with efforts to trim Cal-Maine’s skyrocketing profit margin and capture market share. Yet we found no evidence of aggressive price competition among the major egg producers over the past year,” the group wrote in a letter to the FTC.
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