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How Will Recent Changes in the Fed Affect Interest Rates and Inflation?

On November 2nd, President Trump nominated Jerome Powell for the position of Fed Chairman. He had previously been a member of the Federal Reserve Board of Governors. Governor Powell will be replacing the current Fed Chairman, Janet Yellen, in the coming weeks. He will preside over the seven-member Federal Reserve Board of Governors who set the interest rate and control the U.S. money supply. It has been argued that the Fed chairman is the most powerful appointed position in the U.S. government. Over the past few weeks Powell has testified in front of Congress as part of the confirmation process. He has indicated that his policy decisions will likely mirror Yellen’s past decisions.

Yellen’s monetary policy focused on gradual interest rate increases aimed at curbing growing inflation. During his Congressional confirmation hearing, Powell said, “I think the case for raising interest rates at our next meeting is coming together. I think that conditions are supportive of doing that.” At the December meeting, he is likely to lead the Board of Governors through a raise in the interest rate, which is expected to lower inflation through a decrease in disposable income.

This graph depicts the inflation rate over the past five years and the anticipated inflation rate over the next five years:

    Questions:

  • Why would this increase in interest rates have this expected effect?
  • What are the risks of rising inflation?
  • Are there any other effects to the American economy with a transition of the Fed Chair position?

Anna Litvak & Gabby Smith

14 thoughts on “How Will Recent Changes in the Fed Affect Interest Rates and Inflation?

  1. murrayc20

    An increase in intrest rates through monetary policy would theoretically decrease inflation. Increasing interest rates would reduce disposable income for households, reducing consumer spending. This would then decrease price levels; lower price levels means that consumers could buy more product per dollar, which would decrease inflation (which is the lessening of the buying power of a dollar).
    There are many issues with rising inflation. One would think that if inflation is rising, the rest of the economy adjusts. This is not true because many peoples' incomes are fixed based on long term contracts so they do not adjust to inflation. However, prices on consumer goods rise, real estate prices rise, and investment prices rise, overall hindering the individual and the economy.

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  2. mcconnellm20

    Increasing interest rates is going to lower inflation. By increasing interest rates, people are going to spend less money on other things because they are going to increase their savings. As a result of people spending less of their disposable income, the economy is going to slow in growth, which will lower inflation. An increase in inflation causes a rise in price. Because the price level increases, the economy suffers. Another consequence of rising inflation is falling real incomes. It should be interesting to see how the new Fed Chair compares to Yellen. Because he claims a lot of his policies will mirror those of Yellen's, it will be interesting to see the differences and how those differences will affect the economy.

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  3. denatalec20

    Increasing interest rates is going to make the American dollar more "expensive." This will decrease investment in goods like homes and office buildings. While this will decrease inflation because it will strengthen the value of the U.S. dollar, it will also have the affect of decreasing employment. With the dollar more expensive, companies will be unable to support their current number of employees.

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  4. mizeo20

    Like the others above me have already said, an increase in interest rates will result in less consumer spending. The cost of borrowing money is higher, and savings rates are more attractive, so more consumers will turn to saving instead of spending. Simple answer... an increase in inflation means increase in prices, purchasing power of the dollar goes down. I think he will stay true to what he says in this transition. Though Powell is the only fed chairman in history to not have a Phd in economics, he has worked in the fed for a very long time and is very qualified. It will be an effortless transition.

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  5. Kaitlyn Fitzsimmons

    As the executive officer of the Federal Reserve, one of the chairman's duties is to establish moderate interest rates. Most Americans believe that that current rates are well below moderate as we are operating in a low interest rate environment as a result of government intervention following our last financial crisis.
    One concern relating to increased fast-paced inflation is the diminishing purchasing power of the U.S. dollar and its effects on consumer spending. (People will struggle to afford basic necessities and products with low price elasticity will be foregone). Real returns on investments will be lower and discourage further investment, stalling the economy. On the other hand, gradual inflation is relatively natural and shouldn’t necessarily be feared.

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  6. gianakosa20

    Using monetary policy to increase interest rates has some unfortunate side effects.
    Increasing interest rates cause investment to fall (mainly in areas such as new residential construction and inventory investment), as crowding out occurs. At the same time, the United States dollar will also become more attractive to foreign borrowers, which helps imports, because they will be cheaper for U.S. consumers. With this being said, exports will decrease because they are more expensive to foreign traders/purchasers, hurting domestic export-producing businesses. Additionally, by raising interest rates, inflation will rise, as it will then cost more for people to borrow money. This also affects consumer spending negatively, as there will be less money in the economy to be spent.

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  7. laniere20

    An increase in interest rates would case a decrease in investment spending as well as consumer spending and would cause the value of the dollar to go up. If the value of the dollar goes up, then the US can expect an increase in imports and a decrease in exports.
    Rising inflation will not be good for the economy because it will cause CPI to increase. If CPI increases, it means that living in America has been more expensive, which will cause many problems for the US such as more poverty.

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  8. moodyj20

    Increased interest rates would cause the opportunity cost of holding money to increase, decreasing demand for money in the short run. This would also crowd out investment and strengthen the dollar so exports would become more expensive and decrease. This is a side effect of expansionary fiscal policy as well as contractionary monetary policy.

    Rising inflation is a risk because it makes goods more expensive, which could lead to a decrease in consumer spending and a decrease in overall real GDP.

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  9. shenr20

    In the short term, Powell probably will go along the existing fed policy path, and his effects on the market may not be too big, which has been underlined by overnight dollar and calm reaction of gold. However, monetary policy is not fixed and will evolve with the economy. During Mr Powell's tenure, the US will have an unprecedented exit from its policy of quantitative easing, while the us economy is not in the early stages of recovery. Will wages eventually rise and bring inflation? What should be the interest rate at the end of this round? How long will it last, and when will the next recession come? What policy tools will be needed? These are questions that lie ahead for the new fed chairman.

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  10. Ellie Bradach

    An increase in interest rates will most likely cause a drop investment and therefore overall consumption and purchasing. This will cause a rise in inflation in the future because firms need money to replace the decrease in spending. Rising inflation can both positively and negatively affect firms and households. With high inflation, money becomes worth less, so goods and services cost more. This is especially troublesome who are already struggling to pay bills. The changing of the Fed position also just changes how the money is used and how much is used. This can affect monetary and fiscal policy and at an extreme, overall GDP.

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  11. mitchelld20

    In theory, an increase in interest rates would decrease inflation because it allows for less spending and more saving, which will help to gradually increase the purchasing power of the dollar. Rising inflation could result in many things such as higher costs of living, higher costs of running a business and a wider gap between the low-income group and the higher income group of people. It is nice to know that the new chair of the fed will continue in similar strategy as Yellen, however, there is a limit to how high we would like interest rates to rise. If they continue to rise too much, it will be very hard for some people to borrow money, making it virtually impossible for people of lower-income brackets to make any sort of investments. In addition, when investments decrease, consequently the economic growth will decrease because in order for the economy to prosper, there must be money invested within it.

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  12. gianakosa20

    I actually think Donald Trump's nomination of Jerome Powell as chairman of the Federal Reserve Board is a fairly uncontroversial move. He was originally nominated to the Fed board under Barack Obama, indicating that he is a pretty neutral, bipartisan choice. Because of this, I can't see him making any drastic change within the Fed.

    If his interest rate policy is to implement gradual increases, inflation might decrease as hoped, but other side effects will result as well. Investment will be negatively affected and crowded out. Consumer spending will decrease. Exports will decrease as they will be more expensive for foreigners.

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  13. Robert Griffin

    High inflation rates are dangerous because they could leave average working-class people unable to keep up with rapidly rising prices due to their stickier wages. Their market basket would become too much for them to pay for, leading them to cut certain things out of their spending budget, decreasing their quality of life. The high interest rates would increase cost of borrowing, making it difficult for small businesses to take out loans they can pay off. Therefore, they would spend less, meaning that they save more money. As a result, there would be less money flowing in the economy, which would cause the inflation rate to dip down, as the administration is hoping for.

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  14. compolir20

    This is essentially a similar concept to Paul Volcker's handling of stagflation in the late 70's. Perhaps less drastic under Yellen and Powell, the raising of interest rates in this context will reduce inflation. Using the Philip's curve we know that decreases inflation will correlate to lower unemployment so we should expect to see a continued reduction in the unemployment rate going forward. This strategy makes sense following the Great Recession in which we saw large scale unemployment increases.

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