From The New York Times, I’m Michael Barbaro. This is The Daily.
Later today the U.S. government is expected to deploy its most powerful tool for fighting inflation, knowing full well that it will weaken the economy. I spoke with my colleague, Jeanna Smialek, about why that is and the painful lesson from a previous era that has convinced American policymakers that this is the right path.
It’s Wednesday, March 16th.
Jeanna, The Federal Reserve— in just a few hours, we think— is going to raise interest rates in order to lower inflation in the American economy. Can you just help us understand the mechanics of that? How does that work?
So as everyone knows, prices are rising really quickly right now on cars, on meat, on couches. And there are a few reasons for that. The government spent a lot of money at the start of the pandemic and throughout last year to sort of blunt the impact of the coronavirus and its effect on workers.
Right, there were stimulus checks, for example.
Exactly. And that spending fueled really strong demand. Unfortunately, that strong demand collided with supply chains that were all messed up. And so there were too many dollars chasing too few goods and inflation really jumped up.
Today, even though the government is spending less, the checks have stopped. The labor market is really strong. And that’s helping to sustain this pretty robust demand and it’s keeping inflation rising. And so we have this real problem where prices have been going up a lot. And now the Fed is getting worried that inflation is going to get stuck at this higher rate that they do not want.
And so the idea is if you raise interest rates, if you make it more expensive to borrow money to buy a car or to borrow money to buy a house, then fewer people will do those things. There will be less demand and supply will have a chance to catch up, which will allow price increases to slow down a little bit.
Right. When the Fed raises the interest rate, it essentially pours a tall glass of cold water on the economy. It deliberately tries to slow down spending.
Right. You slow things down to bring inflation under control.
Which has always struck me as kind of strange because what you’re describing is a process of our own government hurting the economy in order to eventually help the economy.
Right. And so …….