I don’t normally comment about the Federal Reserve but it is contemplating a .50 percent increase in interest rates on Wednesday. It is doing this in response to the market’s view, and economists’ view, that the Fed must raise interest rates to counter inflation, which has reared its ugly head.
But we have to ask ourselves, what is causing the inflation? It’s happening because global supply chains have been disrupted, both by war in Europe and by Covid in China. Companies are having to find alternative supplies of key components as well as food and fuel. There are shortages of many manufactured goods because of a global shortage of semiconductors.
Will higher interest rates solve that problem? Not at all. This is a different kind of inflation. It is not the type we saw in the 1970s when the psychology of raising prices and raising wages became part of the fabric of American life. We knew prices were going up but we didn’t care because our wages and salaries also were going up. It took Paul Volcker to raise the prime rate to 21 percent to put an end to that psychological cycle.
Raising interest rates in today’s environment could have disastrous impact because it would discourage borrowing that might be necessary to adjust to a dramatically altered world order. It would have a particularly serious impact on developing nations that are deep in debt. It would raise the value of the dollar, discouraging exports. And if sustained, as the market expects, it would stall the white-hot American real estate market. The Fed should do a better analysis of what is causing this inflation before it embarks upon a potentially disastrous journey of higher interest rates.
