Inflation is NOT Out of Control but Why does the FED Continue to Raise Rates?

The Consumer Price Index for July 2017 came out on Friday with a modest 0.1% tick upward. This comes to a year-to-year basis of 1.7% which is still below the Federal Reserves 2.0% target rate.

Of course, the Federal Reserve does not use the CPI to track inflation. They use the Price Consumption Expenditures (PCE)  index instead. However, that is not the point. The concern comes with steady/weak inflation while the Fed continues to raise interest rates. The Fed tends to raise rates to control inflation but we do not have that problem. Inflation has been weak for years which is one proof on how slowly the recovery has been since the recession. Nevertheless, lets get back on point. Let me explain why I think the Fed has been raising rates, even though inflation has been well below their 2% target rate.

When the economy enters a recession, the Fed goes into action with their monetary policy. They move to lower rates in the United States which in turn pumps more money into the economy by bank loans for construction, business inventory, car loans, etc. As spending/consumption increases throughout, the U.S. economy climbs itself out of the recession. Please note that U.S. consumer spending plays a BIG part on our Gross Domestic Product.

So, as the economy gets better, prices of goods and services begin to rise and with people continuing to get loans at such low rates, inflation starts to tick upwards. Thus, this is when the Fed starts to slowing raise rates back to normal levels to prevent high inflation. Once the economy is stable and Fed has rates back to normal levels, the Fed goes back to overseeing the economy from the backseat.

The different today is that inflation is not out of control but the Fed is still raising rates.

My theory is this:

The economy is much better than it was during the Great Recession but we are still trying to grow at a faster pace than we currently are doing. Nevertheless, during this time, the Fed has let rates be a historic lows to help jump start the economy but it has not worked to its full effect. It now has been many years since that recession and history tells us that another recession is due fairly soon but do not be alarmed. It should not be as bad. It SHOULD NOT be. I am guessing of course.

The Fed must be thinking the same thing so must be getting prepared for the worse. If we are hit with a recession, say next year, and rates are still this low, then what is the Fed going to do? They will not be able to the economy buy lowering rates since they are already low. This is why they are slowing raising rates so they can have bullets in their chamber.

One thing I do worry about if the Fed is going to make it in time. What I mean is, is the Fed going to get rates back to normal levels before the next recession hits. It’s difficult. If they go too fast, the economy might not react positively and they could be why we enter a recession.

Honestly, I do not think they will reach normal levels in time but will be darn close. We can only hope that the recession is not too rough or long on our economy.

 

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