The Federal Reserve is keeping interest rates high to fight inflation. The concept is that if interest rates are high, it will slow down an overheated economy by making it more difficult to borrow money. The problem is that the system the Federal Reserve (The Fed) has been using for the last almost 50 years, since the Paul Volker era, is outdated and has changed in the ways inflation occurs. The traditional view of inflation that the Fed is using looks at overall inflation, not the root causes of inflation. I will argue that there are different types of inflation that do different things to the economy overall.
The Fed is looking at overall inflation, not the root cause of inflation. This is the wrong way to view inflation, as it comes in different ways. Overall inflation is basically watching all prices of goods and services move up. This has been the only number the Fed has been using for the last 50 years. We now know that inflation is caused by many things, and interest rates are only one way inflation can happen. Interest rate inflation is when the interest rates are low, and the demand for money is high. With low-interest-rate inflation, there is both consumer and corporate demand for money. This demand comes in the form of refinancing high-interest-rate debt for lower rates. Interest rate inflation also creates demand for businesses to expand and invest in expansion by using low interest rates or cheap money to do so. This is where the Fed should raise interest rates to slow inflation, as this will cool the demand for money and the demand for goods and services.
Another type of inflation is supply-side inflation. Supply-side inflation is where there are not enough goods to go around, so the price of those goods rises to fight off the demand for the goods. An example would be computer chips. If the supply of computer chips is low and the demand is high, then the price of those chips will rise. This concept works for all food items as well, and just about anything where the demand is high and the supply is low. So if the Fed sees inflation caused by supply-side inflation, they will stick to their concept of raising rates to cool demand. This is the exact opposite of what should happen in this situation. If the Fed raises rates to offset supply-side inflation, what you will get is even higher prices as those suppliers of the goods have to borrow money at higher prices to expand the supply to meet the demand. What this does is make the end product more expensive as it costs the producer more to produce those goods, thus you will get even more inflation. This has been one of the biggest downfalls of this approach to fighting inflation with higher interest rates by the Fed.
What we are seeing today is Oil-Based inflation. This is inflation caused by higher oil prices. Higher oil prices mean it is more expensive to produce the power required to make and deliver goods to the market. Oil-Based inflation is nothing new, as we saw this play out in the 1970s when the Fed had interest rates upwards of 20% and a low supply of oil. This high-interest rate environment stagnated the economy with oil-inflation, and the Fed tried to fight inflation by raising the interest rates. This is very similar to what we are seeing today. The idea of raising rates to fight off demand for energy is a concept that can’t win by design. All the Fed is doing by raising rates to fight oil-based inflation is further stagnating the economy. Oil-based inflation is what we are experiencing today, and the Fed is keeping rates artificially high in the hopes it will slow the demand for goods and services, and what it is actually doing is creating more debt for consumers with higher interest rate loans and credit cards. Consumers have to eat, drive to work, fix things that break, and pay their mortgages or rent. In turn, consumers end up paying for high interest rates that the Fed has imposed on them. This is not working at all, in fact, it is making things worse for the average consumer as their personal debt rises and keeps rising until they can no longer afford to live the life they have been living. What we are seeing currently is that the average citizen has not been able to save money for a rainy day, and the majority are facing serious economic problems resulting from high interest rates. The average American is working every day just to put food on the table and live a basic life, and some are on the verge of foreclosure and losing their house as a result of the higher interest rates.
Another kind of inflation is demand-side inflation, which is where the demand for goods and services exceeds the supply. I like to call this consumer inflation, where the consumers are driving up prices. Generally, this occurs when there is too much money supply in the economy, and people are spending faster than producers can produce the goods and services. This type of inflation can be slowed by the raising of interest rates and effectively cutting the supply of money in the economy. Higher interest rates for consumers will cause them to slow down the purchasing of goods and services, and it will cut the supply of money in the economy, thus cooling the economy off.
To conclude, it is my opinion that in our current economy, we are seeing oil-based inflation. I would argue that if the Fed were to cut interest rates by half a point, it would give consumers relief from high-interest-rate debt. By lowering the interest rates now, what you would see is consumers being able to refinance their existing high-interest-rate debt and simply get relief. Lowering interest rates in this economy with oil-based inflation would not create more demand for goods and services; it would simply allow Americans some debt relief. America has almost $2 trillion in credit card debt, and with lower rates, some of the debt would be able to be refinanced to lower rates, providing relief for Americans, not more inflation. It is complicated to understand inflation and how it is caused and how to combat it, but with some logic and new thinking, I believe we all could benefit, but will the Fed listen or understand or simply go with the system they have used for over 50 years now?