Monetary Policy | The US central bank raises the key interest rate despite the instability

of the United States the central bank announces that it will continue to tighten monetary policy.

It raises its key interest rate by 0.25 percentage points, which corresponds to investors’ prior expectations. As a result of the decision, the interest rate range is 4.75–5.00 percent. The last time the policy rate was as high was in 2007.

The Open Market Committee, which decides on monetary policy, was unanimous. It justifies its solution with rapid inflation.

The average estimate of the members of the Open Market Committee is that the appropriate upper limit of the policy interest rate range would be 5.1 percent this year. This is a hint that the central bank may tighten monetary policy one more time this year. Estimates are not promises, however.

Director general Jerome Powell explains the decision in more detail at the press conference.

Last times, investors have pondered whether the central bank should abandon interest rate hikes due to instability. It would have been a bold decision and probably raised suspicions that the central bank assessed the turmoil in the financial markets to be greater than known.

“The US banking system is stable and sustainable. Recent developments are likely to tighten credit conditions for households and businesses and weigh on economic activity, hiring and inflation. The extent of these effects is uncertain,” the Open Market Committee states in its statement.

Due to the increased interest rates, financing from banks is no longer available on as favorable terms as before, which curbs inflationary pressure. When financing is more expensive than before, it can force customers to withdraw their deposits, and banks are quickly in trouble.

In addition to this, the values ​​of the long-term bonds on the banks’ balance sheets decrease as a result of the rise in interest rates, which means that banks that have taken a large risk are in trouble. Especially if they have not purchased interest rate protection for their bond investments.

A year during the period, the central bank has tightened monetary policy nine times and resorted four times to an exceptionally large interest rate increase of 0.75 percentage points.

The root cause of the tightening of monetary policy is rapid inflation, which many economists consider the most significant threat to the US and Eurozone economies.

Due to the rapid increase in prices, the real income of households shrinks and the costs of companies increase, which means that consumption and production decrease.

In February, the inflation rate in the United States was 6.4 percent. According to the central bank’s price stability objective, inflation must be two percent on average over a long period of time.

On Wednesday in the published new economic forecast, the central bank estimates that the economy will grow by 0.4 percent this year and 1.2 percent next year and 1.9 percent in 2025.

It predicts that inflation will slow to 3.3 percent this year, 2.5 percent next year, and 2.1 percent in 2025.

In the United States, in addition to the energy crisis, inflation has been accelerated by a strong fiscal policy stimulus that was started during the worst phase of the coronavirus pandemic. The stimulus has increased the imbalance between supply and demand.

The economy is also overheated, as the demand for labor is greater than the supply. In this case, employers have to compete for labor with wage increases. They, on the other hand, are apt to accelerate inflation.

Monetary policy by tightening, the central bank tries to bring demand and supply into better balance, as a result of which inflation slows down over time.

The fastest rate of inflation was last year in July, when consumer prices rose by 9.1 percent from a year ago.

The tightening of monetary policy usually starts to slow down the rate of inflation after six months and reaches its full effect in a good year.