Fed rate moves can’t address some price spikes
The Federal Reserve's rate hiking campaign — it jacked up rates again Wednesday in its bid to bring inflation down — won't stop idiosyncratic price spikes that constantly occur in an economy.
Driving the news: Drought-related cutbacks in the projected supply of U.S. agricultural products prompted investors to place bets that prices for staples such as wheat, corn, eggs and butter will be higher in the future.
Why it matters: The battle against inflation is top of mind for many Americans. Events like the heat and drought in the Western U.S. remind us that short-term drivers of some prices are far beyond the Fed's ability to control.
- Energy prices, which fluctuate based for a range of political, logistical and commercial reasons — like drillers deciding they will or won't boost production — are another area where the Fed has only modest control, at least in the short term.
How it works: Prices rise when demand for goods and services exceeds what the economy can produce.
- When the Fed raises interest rates, it affects the demand side of that equation: borrowing money for things like buying homes or investing in businesses becomes more expensive, so, fewer people borrow money to do those things. Voila! Demand comes down.
- On the other side, raising interest rates can do little to fix supply shortages caused by, say, the weather or COVID lockdowns.
Between the lines: The volatility we're seeing in food prices explains why the Fed's preferred gauge of price growth — known as "core" inflation — excludes food and energy prices.
- Food and energy are prone to the kind of short-term ups and downs that have little to do with the central bank's core business of making borrowed money more or less expensive.
The bottom line: The Fed is less concerned with any one individual price than it is with the overall price level of the economy.
- Fed chair Jerome Powell says central bank believes the economy remains out of balance, with far too much demand for the amount of goods and services the economy can currently supply.
- In other words, expect the rate hikes to continue.