Federal Reserve Vice Chair Lael Brainard said on Monday that the central bank increasing federal funds rate targets will have dramatic effects on economic activity.
Policymakers raised target interest rates by 0.75% last month, a move which followed two identical hikes in June and July, in an attempt to relieve elevated inflationary pressures. Brainard warned during a conference in Chicago that economic growth will be “essentially flat” in the second half of this year.
“The moderation in demand due to monetary policy tightening is only partly realized so far. The transmission of tighter policy is most evident in highly interest-sensitive sectors like housing, where mortgage rates have more than doubled year to date and house price appreciation has fallen sharply over recent months and is on track to soon be flat,” Brainard commented. “In other sectors, lags in transmission mean that policy actions to date will have their full effect on activity in coming quarters, and the effect on price setting may take longer. The moderation in demand should be reinforced by the concurrent rapid global tightening of monetary policy.”
Indeed, the 30-year fixed mortgage rate remained below 3% for much of the past two years, according to data from government-backed mortgage company Freddie Mac. Since the beginning of the year, however, the rate has surged from just over 3% and reached 6.7% as of last week — marking a 1% rise over the course of only five weeks.
The Federal Reserve had initially pegged a near-zero target interest rate and acquired government bonds in order to stimulate the economy during the lockdown-induced recession. Many leading economists have criticized the central bank amid the return to a contractionary monetary regime, claiming that officials who were slow in their response to rising price levels over the past two years are now inflicting harm through their excessive zeal to combat inflation.
Price levels between August 2021 and August 2022 rose 8.3%, according to data from the Bureau of Labor Statistics, marking a slight moderation from an 8.5% year-over-year increase in July and a 9.1% year-over-year increase in June. The M1 money supply, which includes liquid forms of money such as demand deposits and checking accounts, rose from $4.8 trillion to $16.2 trillion between April 2020 and May 2020 alone, according to data from the Federal Reserve. The metric peaked at $20.7 trillion in March 2022 and has since declined slightly.
“Monetary policy will be restrictive for some time to ensure that inflation moves back to target over time,” Brainard continued. “It will take time for the cumulative effect of tighter monetary policy to work through the economy broadly and to bring inflation down.”
In a hawkish speech delivered two months ago, Federal Reserve Chair Jerome Powell said that policymakers still intend to reduce inflation to 2%, the rate largely maintained by the central bank for the past three decades, and emphasized that the institution ought to revive its mandate to take responsibility for stable inflation.
“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,” Powell cautioned. “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”