Federal benchmark rates continued to rise after the Federal Reserve approved its third-consecutive increase this year by adding 75 basis points while projecting another increase. They expect the rate will increase until reaching 4 to 4.5 percent by the end of this year, a level we have not seen since 2008. This increase comes as expected in the battle against soaring inflation rates, which is at 8.2 percent annually, near its highest rate in 40 years. This increase was followed by negative responses on the stock market. The Dow Jones Industrial Average (DJIA) sunk 19.38 percent while the S&P 500 suffered a 23.64 percent decline on a year-to-date basis, falling to the level that people call a “bearish market.” The future economic forecast is even more gloomy. While the first two quarters of 2022 saw negative growth, experts claim that the third quarter’s Gross Domestic Product (GDP) is also close to zero. Consequently, the rise of interest rates will affect the economic recovery after it was hit by the last recession during the pandemic. Households, particularly low-income families and workers, will be the first to be affected as the hike in interest expenses will increase prices for products and services while they face the danger of unemployment. The United States will, once again, face the threat of recession.
While there is no standard for defining a recession, most experts refer to a recession as a significant decline in GDP for two consecutive quarters. The National Bureau of Economic Research (NBER) offers a broader definition of recession by taking into account several factors, such as the decline in GDP, the decline in real income, the rise of unemployment, the slowed production and sales of the industrial sector, and the lack of consumer spending. Many of these factors affect each other, meaning the decline in GDP will likely constrain consumer spending, which affects the production of products, and in turn, gives rise to the unemployment rate. According to NBER, a recession happens for months, while the average recession lasts for 21.6 months. The most recent recession in the United States is the Covid-19 recession, which lasted around two months.
Rising inflation rates is one of the common causes of a recession. When inflation is high, the price of goods and services increases and hampers people’s ability to purchase. Because the value of money is diminished, people tend to spend more of their money on everyday goods rather than save it. Consequently, people will ask for a wage increase, and in turn, the company will increase the product’s price again to make up for the labor cost. Then the cycle repeats itself. If this pattern continues for a more extended period, low-income families are the ones who suffer the most because they will not be able to afford the price increase, and their savings will not be enough to cover their expenses.
In order to control the inflation rate to a moderate level, the Federal Reserve resorts to its most helpful method: increasing the federal benchmark rates. Higher interest rates will slow down the inflation rate by tightening monetary policy. Simply put, the Federal Reserve increases the short-term interest rate, which makes money harder to borrow. Business owners will reduce the production of goods and services because of the rise of operational and interest expenses. On the other hand, consumers will be forced to tighten their belts and discourage consumption, driving down demand. Moreover, people will be eager to save money because the bank rate is higher. This pattern will continue until the supply and demand reach equilibrium and create price stability.
Increasing the federal benchmark rate is not risk-free, as it will bring other problems to the table. Jerome Powell, Chairman of the Federal Reserve, said, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.” Low-income families are the ones who suffer the most as they will experience lower quality lives. First, as the interest rate rises, the companies will increase the price of goods and services to make up for their higher interest expenses. The Federal Reserve estimates that prices of goods and services will continue to grow at a level of more than three times the two percent target.. As a result, the low-income families probably will not be able to afford the usual standard of living because everything from gas, water & electricity bills, food, and groceries become more expensive. Moreover, while the increased interest rate encourages people to save money in the bank because of higher investment returns, low-income families might be unable to benefit from this as their savings barely cover their expenses.
Furthermore, the rise of interest rates also affects their repayment loans, such as mortgages and automobile leases. Their installments will increase as the interest rate increases, especially on a floating-rate lease. Accordingly, the rental lease will also become more expensive because landlords tend to pass the increased mortgage rent to their lessee. Finally, the increased rate also has a negative impact on the job market. In a worst-case scenario, the Federal Reserve projects an increase in the unemployment rate to 4.4 percent next year. That would mean the loss of 1.2 million jobs. The combination of increased interest rates and lower demand will diminish companies’ revenue and production, and in return, they will restrict their hiring rate. At some point, some companies might not be able to compensate their workers due to a lack of cash flow. Thus, mass layoffs will probably occur as companies attempt to cut labor costs. Consequently, many low-level employees will be on the verge of unemployment because their positions are the first on the list when companies plan to lower production and are easy to replace when the economic situation goes back to normal.
By Ristyo Pradana