Powell: 'There is room to raise interest rates.'

On January 26, 2022 the U.S. Federal Reserve provided several updates regarding their stance on monetary policy. In a press release, the Federal Open Market Committee (FOMC) announced that the Board of Governors voted unanimously to keep interest rates paid on reserve balances at 0 - 0.25%. The committee also announced that they would continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March.

Over the longer run, the committee’s goal is to reach “maximum employment” and an annual inflation rate of 2%. Earlier this month, Federal Reserve data showed an unemployment rate of 3.9% in December, with approximately 3.6 million fewer people working now then before the pandemic. Their data also showed a 7.1% year-over-year increase in consumer price index (CPI; a common metric for inflation rate), the highest since June of 1982. 

In a post-meeting press conference yesterday afternoon, Fed Chairman Jerome Powell told reporters that "inflation has persisted longer than we thought, and of course, we're prepared to use our tools to ensure that higher inflation does not become entrenched." One tool the Federal Reserve has at its disposal is the ability to adjust interest rates paid on reserve balances. Indeed, in his press conference, Powell clarified that “the federal funds rate is the primary means of adjusting monetary policy.” 

In general, when interest rates are low, money is cheaper to borrow, which leads to more credit, spending and investing in the economy. This causes the economy to grow and inflation to rise. When interest rates are increased, money becomes more expensive to borrow and consumers tend to save because returns from savings are higher. With higher savings and lower credit, spending, and investing, the economy tends to slow and inflation decreases.

Federal funds rate dropped from approximately 1.6% to current levels (0 - 0.25%) in the early days of the pandemic. It appears likely that the Federal Reserve will begin to raise interest rates in March, when their asset purchase taper is completed. According to their press release, “with inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.” Powell reaffirmed this sentiment in his post-meeting press conference, saying “I think there’s quite a bit of room to raise interest rates without threatening the labor market.” It’s not clear how many interest rate hikes there will be, however per their press release, “the Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.”