Runaway Inflation, Rising Interest Rates, The Overheated Economy, & The Impending Recession
So what’s all this hullabaloo about inflation–what is it and why is it even so important? So inflation is kind of what it sounds like (think of a balloon inflating–what happens? It gets bigger or grows): inflation is an increase or “growth” in prices. The price of goods (the pizza you ate last night at your favorite Italian bistro) or services (notice that haircut of yours has been getting more expensive everytime you go to the barber!). High inflation is caused by too much money chasing too few goods and services. Now, there’s naturally always a normal rate of inflation or price changes year-over-year that the Federal Reserve targets. (The Federal Reserve or “The Fed” for short, is the central banking system in the country. Other countries have their own central banks.)
The long-term rate of inflation the Federal Reserve targets is 2.0% year/over/year growth. This is measured by the Personal Consumption Expenditures (PCE) statistics of Americans–an index tracking how we Americans spend our money. But as you may have been seeing in the news, recently inflation has gotten out of control to a 40-year high and wayyy over the Fed’s preferred target rate (recent market stats say around ~8% year over year. (It’s even worse in other parts of the world: The United Kingdom’s CPIH Goods Annual Inflation Rate jumped to a staggering ~15%. If the price of our foods and the services we buy increase by that much, all else equal and salaries not keeping pace with that price increase, we’re all poorer for it as our purchasing power declines. And wages are NOT keeping up with the inflation rate (statistics show 5% wage growth over the last 12 months to end October 2022 as a comparison).
Naturally, consumers’ purchasing powers declining rapidly is a problem. To prevent this from getting out of control, the Fed began raising interest rates (they do this in part by adjusting the Fed funds rate, the cost that banks have to pay to borrow from the Fed) from historically low rates (almost near 0%). Interest rates are the cost of borrowing money. When interest rates rise, the cost of money increases, and hence there’s less money circulating around the economy as a result. This helps reduce the “too much money chasing” part of the inflation problem. However, a big consequence of rising rates is that it really dampens demand and the morale of an economy. Think about all the things that are impacted by interest rates (your mortgage, auto loans, student debt). Similarly, for companies, they borrow to fund their business expansion and growth plans; if the cost of borrowing money increases, they put a halt to those plans.
Accordingly, we have a big issue now: declining demand, layoffs (just look at the news and you’ll see another bank or tech company laying off workers), and what’s likely an impending recession. In times like this, it’s important to save and invest wisely. Check out some of our personal finance section articles to prepare well for these difficult times.